Bank bad loans are down, but it’s because of accounting

This has happened primarily because of an accounting eventuality. Basically, loans which have been bad loans for four years can be dropped from the balance sheet of banks by way of a write-off. In that sense, a write-off is an accounting eventuality.

During this period of four years, a bank ends up adequately provisioning or setting aside enough money against the bad loan to be able to write it off. Also, this does not mean that a bank has to wait for four years before it can write off a loan. If it feels that a particular loan is unrecoverable, it can be written off before four years, as long as it has been adequately provisioned for.

In FY22, the total amount of loans written off stood at ₹1.75 trillion. In fact, between March 2018 and March 2022, the total amount of loans written off stood at ₹8.53 trillion. Nonetheless, total bad loans of commercial banks have fallen only to ₹7.42 trillion from ₹10.36 trillion.

Of course, the overall bank lending has also grown during the same period and that needs to be considered as well. The bad loans rate, or bad loans as a proportion of overall lending carried out by banks, had stood at 11.2% in March 2018. By March 2022, this fell to 5.9%. However, this fall could have been faster if it wasn’t for the accumulation of fresh bad loans by commercial banks.

In fact, in FY21 and FY22, banks ended up accumulating fresh bad loans worth ₹2.56 trillion and ₹2.86 trillion, respectively. In FY19 and FY20, the fresh bad loans stood at ₹1.35 trillion and ₹2.22 trillion, respectively. Prima facie, the spread of the covid-pandemic seems to have led to a slight increase in loan defaults. This is a reason for worry.

Further, over the years, banks have had to set aside an adequate amount of money to be able to write-off bad loans. A bulk of these bad loans had been accumulated mainly by the government-owned public sector banks. Before October 2017, the government would set aside money in the annual budget to recapitalise these banks. Since then, things have changed and the government now issues recapitalisation bonds.

The government issued bonds which were bought by the public sector banks. It then used this money to recapitalise these banks. In short, this is how the government borrowed the deposits of banks and invested it back into the banks. What this did was that it helped the government control its fiscal deficit.

This way of recapitalising public sector banks is what economists called budget neutral. The government took money from banks by issuing bonds and then used that money to recapitalize the banks. Hence, to that extent, it wasn’t spending money earned from taxes or borrowing money, to recapitalize these banks. This helped control the fiscal deficit.

As per the Union budget, as of March 2022, the government has issued recapitalisation bonds worth ₹2.79 trillion in total. These bonds pay an interest of 6-8% per year. The interest that the government pays out is paid out of the annual budget. Nonetheless, the first of these bonds matures only in 2028 and their maturity then continues until 2036.

When the bonds mature, they will have to be repaid and for that, the government will have to make annual allocations in the budgets of those years. Hence, the idea of recapitalization bonds in a way kicked the bad loans problem down the road, instead of allocating money to recapitalize banks every year, the government decided to sell bonds which they would only have to repay in the years to come.