Why do banks write off bad debt

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Why do banks write off bad debt? 

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. 

What is considered a bad debt?

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.

Why are loans written off by banks in India?

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.

What is the main reason why banks prefer to write-off bad loans instead of keeping them open in their account books?

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.  

Can Personal Loan be written off?

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:

  • Lenders expect to get their money back within the fixed period after providing a loan to borrowers. But if the borrower does not repay the loan amount, the lender will give them a certain period of time to pay. If the borrower is not eligible or the amount can’t be recovered in that given time, the bank writes off the loan and reports this to credit bureau who are associated with.
  • Once the loan is written off, it is recorded against your loan in your credit reports. This will reduce your chances of trying for a new loan or credit card in the future. Simply put, it will decrease your creditworthiness significantly.
  • Your credit score will also take a major down fall if your lender writes off your personal loan.

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.

If you are struggling with repayment of debts, the last thing that will hit the course is to stop paying them. This can lead to recovery agent harassment and severely affect your credit score. If you feel you are not in a position to repay your EMI’s, a debt solution is always available. A debt solution program with us will give you an affordable Debt Management plan so you can repay your debts and live stress-free. Contact SingleDebt on +91 961 910 3594 or fill out the form either on the home page or contact page

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