Did you ever wonder why banks announce that they’re writing off bad debt? In many cases, banks do not prefer to write off bad debt since loans are their primary assets and source of future revenue.
However, sometimes, there are loans that are toxic and cannot be repaid for years. These loans can be unreasonably difficult to collect and might also affect the bank’s financial statements and can divert resources from more productive activity.
Banks prefer to write off their debts, which are also called ‘charge offs’, in order to reduce their overall tax liability and remove the loans from their balance sheets.
In short, a bad debt is a debt that can no longer be recovered or collected by creditors or banks.
Under the provision or allowance method of accounting, the uncollected debt is credited to the “Accounts Receivable” category on the balance sheet.
Bad Debts are expensed directly under the write-off method. The company debits the bad expense on the income statement and credits the accounts receivable on the balance sheet. There is no ‘allowance for doubtful accounts’ on the balance sheet under this form of accounting.
A bad debt is a negative sign on the balance sheet. In order to clear their balance sheets, banks use loan write-offs instead. It is used in the cases of non-performing assets (NPA) or bad loans.
When a loan is not paid and has been declared a defaulter for more than four years, the loan can be written off. The money that was parked by the bank for a loan write-off is set free for the provisioning of other loans.
A certain percentage of the loan is kept aside by the bank for provisioning a loan.
As per RBI technical guidelines to write off debts, Minimum of 20% (up to one year) to maximum of 50% (more than three years) is the standard rate of provisioning that has to be maintained or kept aside against the bad loans.
Earlier in a case where 12 large bankruptcy cases referred to the National Company Law Tribunal, the RBI asked banks to keep aside 50% provision against secured exposure and 100% for unsecured exposure.
A bank’s loan file is its primary asset and source of future revenue. Therefore, by default, banks do prefer to have their bad debts written-off.
Unrecovered loans which are nothing but loans that could not be collected or are unreasonably difficult to collect can reflect negatively on the financial statements.
Banks will write-off loans, which are sometimes referred to as charge-offs. This is done only to get rid of loans from the balance sheets and reduce the overall tax liability.
A personal loan is an unsecured loan, that means a borrower does not need to pledge any kind of security against the loan amount. Lenders expect the borrower to repay the loan in a given period chosen by them. But they are unable to pay the amount during the tenure and even after the tenure. This is why NPAs consider these loans to be bad debt. So, the answer to the question is YES, personal loans can be written off, if not recovered completely. There are problems associated with writing off debts, and they are as follows:
To clear their balance sheet and reduce the inducements of tax liability, banks often write off bad loans, the most similar form of bad debts for a bank.
It is imperative for banks to maintain a reserve for bad loans. As a result, part of the debt will be recovered and part of it will be written off. This is said to be a part of settlement once the bad debt is written off.
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