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Here’s the good news first. As of March, bad loans of commercial banks fell to 7.42 trillion, from a peak of 10.36 trillion as of March 2018. Bad loans are loans that have not been repaid for 90 days or more. 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 the 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.

Downward trajectory
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Downward trajectory

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

Of course, 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 was 11.2% in March 2018. By March 2022, this fell to 5.9%. Even so, 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, fresh bad loans were 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.

Furthermore, over the years, banks have had to set aside adequate amounts of money to be able to write-off the bad loans. A bulk of these bad loans had been accumulated mainly by government-owned banks. Before October 2017, the government would set aside money in the annual budget to recapitalize these banks. Since then, things have changed and the government issues recapitalization bonds.

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

This way of recapitalizing public sector banks is what economists called budget neutral. To that extent, the government wasn’t spending money earned from taxes or borrowing money to recapitalize these banks.

According to the Union budget, as of March, the government has issued recapitalization bonds worth 2.79 trillion in total. These bonds pay an interest of 6-8% per year. The interest that the government pays is paid out of the annual budget. Nonetheless, the first of these bonds matures only in 2028 and 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 have to repay in the years to come.

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