Banking Article, Banking Finance 2021, Banking Finance May 2021

WRITE-OFFS REVISITED


Write-offs by banks is a sensitive issue in the public eye. There is always a brouhaha when these figures are revealed by the banks or some enthusiastic researcher obtains the information under RTI and tells all. Whenever quarterly and annual results of banks are announced, the figures of write-offs and NPAs invariably invite close scrutiny.

The analyst community, shareholders and investors minutely probe the levels and more importantly the trends and expected future of these balance sheet/off  balance sheet items and their impact on the profitability of the bank and its financial health.

Most bank chairmen know that they have to be well prepared for the glare of search-light on this subject. This could be one reason that bank chairmen often take refuge under the oft quoted refrain that “the worst is behind us..”. That this hope rarely comes true is another matter.

 

Though the concept of write offs  has been in place for quite some time, it gained prominence after the implementation of  the Narasimham Committee Report (1991) recommendations regarding, inter alia, the 4 fold assets classification according to quality  ( Standard, Sub-Standard, Doubtful and Loss) and income recognition norms.

 

The concept gained further traction with RBI’s Master Circular dated 30/08/2001 on Prudential Norms on Income recognition, Asset Classification and Provisioning pertaining to the Advances Portfolio wherein under provisioning norms for Loss Assets.

It clearly states, “The entire asset should be written off. If the assets are permitted to remain in the books for any reason, 100 percent of the outstanding should be provided for.”

In the same circular, a reporting format for NPAs too seeks data on Gross NPAs and Total Provisions held with a separate below the line reporting requirement of “Technical write off of Rs. ………. crore”  and “amount of technical write off (Rs…….. …crores) and provision on standard assets (Rs………..crore)”.

Further in response to a news item in the Indian Express of 09/02/2016, under the heading “Rs. 1.14 lakh crore of bad debts: The great government bank write-off”, RBI reiterated and clarified, “Writing off of non-performing assets is a regular exercise conducted by banks to clean up their balance sheets.

Substantial portion of this write-off is, however, technical in nature. It is primarily intended at cleansing the balance sheet and achieving taxation efficiency. In ‘Technically Written Off’ accounts, loans are written off from the books at the Head Office, without foregoing the right to recovery.

Further, write offs are generally carried out against accumulated provisions made for such loans. Once recovered, the provisions made for those loans flow back into the profit and loss account of banks.” (rbi.org.in – “Bank Write-offs Clarification” dated 09/02/2016)

 

In this context, RBIs use of the words Head Office seem inapt as no separate balance sheet is published for branches and head offices do not maintain accounts. The balance sheet is drawn up and published for the bank as a whole and, insofar as the loans and deposits are concerned, is just an aggregation of branch level positions. Suffice to say that the loss asset is written off from the bank’s books. Nonetheless, the clarification sufficiently confirms that the write off exercise by banks is a standard and acceptable practice.

 

It is therefore quite surprising that as late as 2017 the former Reserve Bank Deputy Governor KC Chakrabarty had questioned the practice of “technical write-offs” stating such write-offs are scandals that create non-transparency, destroy the credit risk management system and bring all types of wrong-doings into the system.

“Technical write-offs by Indian banks are inequitable and should be stopped. It is a big scam. Small loans are rarely written off, most of them are big loans,” he told the Indian Express. (Quoted from Indian Express February 07, 2017).

 

The former finance minister Chidambaram is reported to have recently said that one cannot deny the rule that banks can write off loans technically and recoveries can continue against willful defaulters, but why has the rule applied to fugitives, who fled the country, after committing frauds.

“One is not denying such a rule that can be applied to a willful defaulter. But, we are asking these are fugitives and they have left the country and are absconding. Why are you applying this rule to Nirav Modi, Mehul Choksi, Vijay Mallya,” he said at a press conference conducted through video conferencing.

The former finance minister said, “When they are fugitives, the technical rule in the book should not be applied to them. This is my view.” (The Economic Times, PTI April 29, 2020).

 

When a former FM and an ex-regulator and former chairman of two banks make such statements they throw up serious questions regarding conceptual clarity about write offs and their consequences. Admittedly, the former FM’s statement is politically loaded and possibly meant for creating and sowing ripples of doubt amongst domestic constituents regarding intent and bonafides of the decision makers, banks and the government.

Similarly, attributing overtones of “scandal” to write-offs is also quite perverse since the process has sanction of the banking regulator. Bank boards and management work within approved framework and regulatory guidelines. They are highly unlikely to deviate on account of compliance issues.

 

Of course, it is not an intention to dissect and impute meanings to the two views quoted above but just to make the point that if very learned and erudite persons hold such a view we cannot fault the man on the street from looking at write-offs with a jaundiced eye.

In actuality, write offs have little to do with the status of the defaulter – whether he is a fraudster and absconding, gone into hiding, or even dead – the physicality is not material to the aspect of recovery. It is relevant only to the extent of apprehending and putting behind bars a fraudster against whom criminal proceedings have been initiated.

An FIR in such matters may be at the behest of the bank but the catching of culprits, bringing them to book and determining criminal culpability, breach of trust, cheating, diversion and defalcation of funds via a credible and legally acceptable investigation is the sole domain of the law enforcement agencies, most certainly not under the purview of banks.

 

Banks are focused upon recovery of public money and physical absence in no way impairs banks rights and legal remedies at proceeding against the estate of and encashing known/unknown assets and collaterals of the defaulters towards recovery of their dues. This is the crux of the matter and is the core issue underlying the concept of technical write-offs.

 

The reason for the discomfort with write-offs is that it is widely held that banks are wasting public money and taking advantage of technicalities to hide their indiscretions. It is felt that large corporates and their promoters are allowed to go scot free at the cost of public money.

The public perception is one of lost resources, money down the drain and no accountability of either the bank or the corporate for such acts. This is very agonising and difficult for the public to digest and they invariably make a comparison of the differing treatment given by banks in recovery of loans in the retail segment (personal loans, farmers loans and MSMEs) against that in the corporate and large business segment.

It is felt that while in the retail segment loan recovery is brutal and banks hound the borrower for repayment, in the large business segment such stringency is not visible and write-offs are indicative of this laxity. This is their basic gripe – that even though their deposits fund corporate loans, the playing field is not level and weighted against them – which has not been addressed by the banks.

Banks very rarely make efforts to clarify the distinction between technical write-off, complete waiver (for example, the Agriculture Debt  Waiver and Debt Relief Scheme, 2008 and other such loan waiver schemes from time to time), an actual crystallised loss called a ‘hair-cut’ or how the loans in the two segments merit differential treatment.

 

In fact, troubled by the stigma associated with write-offs and to stress upon the pure accounting practice of the transaction, SBI has changed the nomenclature of such entries preferring not to call them by the hitherto traditional write-offs.

Since FY17, the bank’s presentation to analysts has started calling it “transfer to AUCA” instead of write-off. The transfer to AUCA (Advance Under Collection Account) clearly implies that the debt is under recovery and the process of collection is under close watch of the concerned stressed asset recovery vertical of the bank with focused intensity and rigour.

 

Nonetheless the question of transparency in respect of write offs and NPAs continues to be bothersome. Should the write off amounts form an inseparable component of the NPAs of banks? In a recent article in The Economic Times, Ghosh and Jha (ET “The Technical ‘Write-Off’ Passage” dated 13/08/2020) have held that “..it is foolhardy to add AUCA numbers that are fully provided for in off-balance sheets to GNPA, as it amounts to double counting and significantly distorts the GNPA-plus-AUCA number for no apparent benefit.”

This appears to be a fallacy as in the interest of complete transparency and to present a fair and true picture of a bank’s impaired assets, the actual NPAs do comprise both the Gross NPAs, as revealed in the audited balance sheet, and the Write offs/AUCA, off balance sheet.

There is no gainsaying that the write off is carved out of the gross NPAs and in a supposed situation of  there being no write offs, the true GNPAs position will necessarily be all inclusive. While the Net NPA to total assets ratio will not be affected, since the write off/AUCA amount is fully provided for, the gross NPA (including AUCA) to total assets will show an upward bias and be a truer representation of the non-performing asset book.

It would therefore appear that write offs do camouflage and hide the NPA burden in a bank’s balance sheet and this aspect needs to be recognised. In fact taking cognizance of this,  SBI in their latest quarterly presentation Q1 FY 1920-21 have courageously done just this.

In a marked departure from the past, they have captured the movement of NPAs by showing the opening and closing GNPAs with AUCA (SBI Quarterly Results Q1FY 21 Analyst Presentation 31/07/2020 : Slide on Movement of NPAs and AUCA = page 24, https://sbi.co.in). This instills a greater transparency in the results and data. The figures for SBI for GNPAs without AUCA and with AUCA  are as under:

 

Closing levels of Gross NPAs + AUCA (Rs. crores)

Mar18.        Mar19.       Mar20.        Jun20.

3,27,653     3,09,755    3,16,684      3,12,175

 

Closing levels of Gross NPAs (Rs. crores)

Mar18.        Mar19.       Mar20.        Jun20.

2,23,427     1,72,750     1,49,092     1,29,661

 

The difference is stark and self explanatory. The first table gives a truer representation of the immensity of NPAs and how technical write-offs disguise the problem. It is therefore high time that other banks too, if not currently doing, emulate this example and declare the GNPA with AUCA figures in their books. This should be made a standard practice as AUCA is after all only a subset of the GNPAs.

 

While improving the data points as mentioned above, another associated issue that has as yet not been emphasised enough is the aspect of recovery. Recently Moneylife, a weekly online personal finance magazine, published a write up under the heading “SBI Writes Off Rs. 1.23 lakh crore of bad debt, recovers paltry Rs. 8,969 crore in 8 years!” (Moneylife -Yogesh Sapkale, 14 July, 2020).

The exclamation mark and the sensational title speaks for itself and underscores the point that recoveries at 7% over the eight year period are insignificant to the magnitude of write off. The article further avers, “This makes a mockery of the aggressive claims by a string of high profile government spokesperson and economic advisors that a ‘technical’ write-off does not stop the recovery process.” They infer this on basis of the following data, reproduced below from the article:

(Source: SBI)”

 

The conclusion drawn from this table suffers on two grounds – (i) not recognising the fact that recovery takes time and may take over 3-5 years; (ii) recoveries are usually not in lump-sum and partial recoveries may be spread across many years.

 

In view of this, a year wise one-on-one comparison misrepresents the position. Thus the possibility that the figure of recoveries of Rs. 8,935 crores (excluding recoveries shown against FY 12-15, assuming them to be recoveries of previous years write-offs) as depicted in the table could represent recoveries against the write-offs in FY 12-17, aggregating Rs. 32,271 crores, cannot be ruled out. Considering the time lag, there may yet have been no or only paltry recoveries under the write offs for the later years FY 18-20. Based on this hypothesis, the recovery percentage improves dramatically to a healthier 28% and affirms the continued pursuance of recovery efforts despite the write offs.

 

The above inferences are, however, mere conjectures based on inadequate and insufficient data and precise clarity will be available only when we have access to year wise and account wise recovery status. Since technical write off/transfer to AUCA is a mechanism for interim parking of NPAs till such time as recoveries are in process, it is important to monitor recovery against each account under the AUCA head.

Recoveries are a long drawn out process and never easy. It may take well over 3-5 years for any recovery which even thereafter, may be, at best, partial. Most recoveries shown in the books are clubbed figures for the year and present no clarity on account wise recovery.

 

While banks would internally be monitoring account wise recovery on an ongoing basis, no information is readily available in the public domain. Banks usually take the plea that on account of customer confidentiality they cannot discuss individual accounts.

However there is a RBI reporting system in place and under RTI or otherwise too the data about write offs can be gleaned/procured. Since the names of the corporate and accounts are in public knowledge, it is incumbent upon the banks, in the interest of transparency, to declare information about recovery against each account.

A system of mapping each account, at least say, exposures of Rs.100 crores and above, needs to be developed so that the oft spoken raison d’etre of technical write off is justified. This will also serve as a confidence building measure in the public eye and confirm that recoveries are actually being effected and the technical write off is not a sham.

Hence the need for mapping, collating and presenting an account wise, year wise write off and recovery there against for say a 5 year period is a felt necessity. Once the recoveries are crystallised and there exist no other means, resource or prospects of any further recovery, the residual amount, if any , will be the true write-off/ haircut incurred by the bank and enable the account to be then removed from the AUCA head and further monitoring.

RBIs recent advice to banks to implement the revised LFAR (Long Format Audit Report) from FY21 onwards wherein Statutory Central Auditors (SCAs) will be required to examine and comment upon recovery from all the written-off accounts during the financial year is a right step in this direction and aligns public expectations and best practices.

This, coupled with the accounting standards under Ind-AS (Indian Accounting Standards)/IFRS(International Financial Reporting Standards), when implemented in banks, is expected to bring about a much better grasp of and a greater degree of transparency about such transactions.

 

In sum, the system of technical write offs is a well established management tool to achieve tax efficiency and balance sheet cleansing without impacting the recovery effort. However it could surely do with improving transparency through publicly available granular recovery data. This will not only help in clearing some of the opacity surrounding write offs but also aid in fine-tuning NPA and AUCA policy prescriptions .

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