What does it mean when banks write off bad debt?

Question

I keep hearing about companies writing off, in response to the mortgage crisis. What does the term mean? And how bad is it for a bank like city group?

Answer 1

wizjp is almost right but not exactly.

When a company makes a loan, GAAP (Generally Accepted Accounting Principles) requires the firm to hold a reserve against expected losses. For example, suppose a manufacturer sells $100 of goods on credit and expects to collect $95 because it knows that some of its customers are deadbeats or will go out of business.

On the firm's balance sheet, the firm would record $100 of receivables as an asset and the $5 as a conta-asset. Thus, the net assets held on the firm's books = $95.

Now, this is where wizjp is incorrect. The $5 is immediately taken against income- that is, it is an expense taken when the loan is made. It is not an expense when the loan actually defaults.


Now, let's say that we are in the future and customers that owe $7 actually default. At this point we write-off the receivable by reducing the amount of assets by $7 (this is the write-off) and the $5 allowance account. As for the extra $2, since we don't have sufficient reserves, we have to take an additional expense of $2.


It is always assumed that a firm will NEVER, NEVER, NEVER collect 100% of it's loans, so writing off balances is not a big deal. What is a big deal is when the firm grossly underestimates the amount of bad debts that it might have to writeoff in the future. This is when you have to be concerned because there is no way to immediatly know exactly how bad things really are.

Answer 2

It means the banks feel those loans are no longer collectible. They then write off the loans (or sell them) to clean up the balance sheet. The banks do factor in a certain % of bad loans, but when it goes way up, the stock price will suffer.
It also affects the capital requirements for loans, so fewer high risk loans will be issued.

Answer 3

They stop showing it on their books as an asset they are going to collect on. It doesn't mean that you don't still owe the amount. And for a bank like Citigroup that has huge amounts of such loans, it's bad.

Answer 4

It means they know who they lent to will not or cannot pay. They take a loss on the money they gave out. Its like if I gave you a $100 and you have been unemployed for 5 years, I would "write off" the fact you would or could repay me.

Answer 5

Means they have assumed it as a bad debit and charged it against their P&L statement as a loss, and against their taxes as a buisness loss.

Answer 6

It means that people are not paying their loans back.

Answer 7

they do that for the paperwork but, you still owe the debt and can be dunned for the money.....