Why bad loans of public sector banks are down by 10%

1) Why is a 10% fall in bad loans significant?

Bad loans are largely loans that haven’t been repaid for 90 days or more. For the first time in years, bad loans of public sector banks have shrunk year-on-year. For years, they did not recognize bad loans, and postponed recognition by restructuring loans and also by evergreening. It was only in 2013-2014 that these banks started recognizing a few bad loans. This changed further in mid-2015, when RBI launched an asset quality review, following it up with other schemes that forced banks to recognize bad loans. That is why bad loans jumped from ₹2.27 trillion to ₹8.96 trillion between March 2014 and March 2018.

2) Why have bad loans shrunk between March 2018 and March 2019?

Loans that have been bad for four years are dropped from the balance sheet of banks by way of a write-off. This is referred to as a technical write-off and is basically an accounting practice. The central bank defines technical write-offs as bad loans that have been written off at the head office level of the bank but remain as bad loans on the books of branches and, hence, recovery efforts continue at the branch level. A lot of technical write-offs has happened between March 2018 and March 2019, leading to bad loans coming down during that period.

3) What does this mean?

As mentioned earlier, public sector banks started recognizing bad loans nearly four-five years back. In 2018-19, bad loans that had been on the balance sheets of banks for more than four years were automatically written off. The total amount of bad loans written off in 2018-19 was nearly ₹1.97 trillion. Also, the fresh bad loans recognized during the course of the year came down by 45%. This explains why the bad loans of public sector banks have come down. Time is acting as a healer. Primarily, the bad loans have been written off. Over and above this, the recognition of fresh bad loans has come down, which is good news.

4) What about the recovery of bad loans that have been written off?

Given the definition of a technical write-off, loans can be recovered even after they have been written off. Between April 2014 and March 2018, the total amount of loans written off by public sector banks was around₹3.17 trillion. Of this, around 14% was recovered previously. This doesn’t sound good. Hence, a loan, once written off, is as good as one waived off.

5) What’s the big-picture implication?

In the future, as bad loans become over four years old, more such loans will see a technical write-off. If these loans are not recovered, the centre will have to keep investing money in public sector banks to keep them going. In 2017-18 and 2018-19, it invested ₹2.06 trillion. If rates of recovery of loans written off do not improve, a lot more money will be needed to keep recapitalizing these banks.