Debt write-off indicates the end of bad assets in the bank ’s balance sheet. It is replaced by equivalent funds. The bank ’s financial statements will show that the written-off loans can be compensated in other ways.
This is necessary to clean up the bank’s balance sheet. The cleaning of the balance sheet means that bad assets are replaced.
From the perspective of the banking industry, the term “write-off” is just an accounting term. This means that the bank or lender does not count the money owed by the borrower. Write-off for a defaulter does not mean that he is forgiven. Instead, the legal proceedings against him will continue.
You can analyze write-off from three angles:
- The bank – its balance sheet will improve.
- The defaulter – has to face consequences including legal actions.
- General public – get a notion that taking loans and not repaying it is profitable.
The best way is to understand the term from the perspective of the bank because this is the responsibility that the bank must bear to initiate the process and have the responsibility to replace the bad assets. Bad asset problem is the survival issue for the bank. The solution is to replace bad assets by write-off.
When the debtor fails to repay the loan for a considerable period of time, and the bank regards the loan as ‘loss asset’, write-off process is initiated. Here, there is a defaulter.
When the government announces specific types of debt waiver scheme for farmers (agricultural loans) and students (education loans), banks can waive the loan, which is equivalent to write off. But here, the government repays the loan to the bank on behalf of the debtor. There is no default.
How written off loans should be compensated:
Securitization – Banks can sell the default assets (buildings, machines, etc.) of defaulters to asset reconstruction companies. Even during this process, only part (and sometimes most) of the loans can be recovered. The rest should be compensated by the bank from its own profits or capital.
Provisioning – The bank uses profits and other money to compensate for the written off assets.
Capital – The bank uses contributions of its shareholders (in the form of new capital) to compensate the written off assets. The recent recapitalization is an example of this format.
Implication of debt write-off on the economy:
Debt write-off relieves banks because it recovers its blocked funds for doing business. Bank is the most important beneficiary if write-off is done in a desirable way. Money blocked for too long will reduce the bank’s lending capacity.
For the economy, once banks become stronger, they can raise funds for more economic activities. In this way, write-off will benefit the economy.
For the defaulter, legal proceedings will put pressure on him and his financial activities will be restricted.
