How Does Writing-Off Bad Debts Works

A “write-off” is an accounting word in recognizing bad debts. The recognition states in the financial statements that the debtor’s assets have no more value. In most cases, debts are written off once they are fully provisioned and there’s no chance of recovery. It will be transferred to the off-balance-sheet records especially when the company has no reasonable expectations in pulling back its cash flows.

How Does Writing-Off Bad Debts Works

A debt write-off does not mean that the loan has been forgiven. The debtor still owes certain money from a bank, but the latter would want to unrecognize the assets of the borrower since all are no longer collectible. However, if the debtor sold something out of the company and resumes paying the debts, the recovered amount will be automatically recorded in the Profit and Loss account.

The Non-Performing Loan (NPL) write-off policy actually gives the banks some benefits. By resolving NPL issues, banks can further focus on their financial intermediation in terms of resources and time. In dealing with הליך מחיקת חובות, instead of being a company of bad debts, banks can allocate more of its resources to new advances. There are also no direct adverse effects on the financial statements once the loans are 100% provisioned and the losses are already recorded in the Profit & Loss account. Also, a decrease in Non-Performing Loans can somewhat increase the assessment of credit risks in banks or financial systems.

By writing-off a loan, banks can maintain their legal position against the debtor. However, they might face additional loss in case they hold collateral of a specific borrowing which in most cases are overvalued. Thus, banks should always give provision for the uncollateralized part of the credit exposure. However, tax and judicial impediments prevent banks or a financial system to fully write-off assets. Banks are restricted from writing-off Non-Performing Loans as per judges’ interpretations and restrictive tax rules.

Further, there is a higher chance of attaining an effective write-off once the loan loss provisioning framework of a particular country is vigorous, wherein they allow realistic recognition of loss promptly. While the borrowing is still in an active restructuring phase, a possible chance of the debtor’s liabilities being restructured is present in a holistic way of restoring financial viability.

How Does Writing-Off Bad Debts Works

In countries with high national NPL ratios, a lot of companies have been considered as “zombie companies” in which their restructuring of debts is constrained due to the non-viability of business firms. These constraints include but are not limited to inefficient in-or-out-of-court resolution and complicated multi-lender cases that result in borrowers not being bankable.

Banks don’t usually assume that they can collect all the loans they approve that is why the Generally Accepted Accounting Principles (GAAP) necessitate banks or lending institutions to allocate a reserve against future bad debts. And when a Non-Performing Loan is written-off, the bank will receive a tax deduction from the credit value. In addition, banks or lending institutions are still permitted to pursue the borrowing and could even generate some revenue from them such as selling off bad debts to a third-party or collection agencies.

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