What Are Haircuts In Banking?

Haircuts, weird it may sound to a lay-men when we say the term applies in the Banking system as well. But yes haircuts are a way to tackle the biggest of all menace i.e ballooning non-performing assets or NPAs faced by the Indian Banking Sector. The state-run banks from last several years are facing this crisis that eventually hurts profitability of the concern.

What Are Haircuts In Banking?

To tackle this front, recently the finance ministry has passed an ordinance in the Banking Regulation Act that now empowers banks to take more stringent actions even before the loan account is declared as non-performing.

Other than the regular course and initiatives taken by the government and finance ministry to tackle this unending problem of NPAs, haircut is yet another option to check non-performing assets.

What actually are haircuts?

Haircut can be understood primarily in two contexts, one in terms of loan recovery, where it is the difference between actual amount owed to the lender by the borrower and the settlement amount to clear the debt. Second is the difference between the loan amount and the actual value of the collateral security kept against the loan.

Haircuts can also be thus referred as a one-time settlement by the banking concern for the asset i.e likely to meet no end that is whose recovery is near impossible on full basis.

In such a case borrower's equity is taken for settling the loan as a one-time settlement.

Other alternatives used by banking concerns for tackling NPAs

1. Sale of Stressed Debt to Asset reconstruction companies or ARCs

2. Corporate Debt Restructuring as in the recent case of Reliance Communications

The step or settlement amount for the bad loan allows the provisioning requirement of the banking concern to come down by the written off amount. The process results in the free mobilization of capital in the system.

On the war-footing agenda against 12 largest NPAs currently underway, Crisil senior director Krishnan Sitaraman is quoted in one of the leading business dailies saying "Based on our assessment of the embedded value in the top 50 NPA cases, we estimate a 60 per cent haircut would be needed on these loan assets. That would mean banks will have to increase provisioning by another 25 per cent this fiscal, compared with nine per cent in the last fiscal".

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