Context: 

Reserve Bank of India (RBI) Governor raised red flags over banks adopting innovative methods for evergreening of loans – covering up the real status of stressed loans of corporates – to project an artificial clean image in cahoots with corporates. 

More on News:

• During the supervision of banks, the RBI noticed certain instances wherein banks were using innovative ways to conceal the real status of stressed loans. 
• In the past, many banks had indulged in dressing up bad loans and given additional funds to companies who didn’t have the capacity to repay.

What is evergreening of loans?

• Form of zombie lending: The process of evergreening of loans is typically a temporary fix for a bank. 
• Motive behind evergreening: 
  • If an account turns into a non-performing asset (NPA), banks are required to make higher provisions which will impact their profitability.
  • To avoid classifying a loan as an NPA, banks adopt the evergreening of loans.

• Indicator of misgovernance: 
  1. Banks delay the recognition of losses due to loan defaults and engage in evergreening, which is essentially the rolling over of debts of unviable borrowers that would have otherwise defaulted.
  2. Bad loans are made to look good many a time by additional lending to troubled borrowers.

Evergreening methods: 

The RBI has come across cases where one method of evergreening, after being pointed out by the regulator, was replaced by another method. These methods includes:

• Bringing two lenders together to evergreen each other’s loans by sale and buyback of loans or debt instruments.
• Good borrowers being persuaded to enter into structured deals with a stressed borrower to conceal the stress.
• Use of internal or office accounts to adjust borrower’s repayment obligations.
• Renewal of loans or disbursement of new/additional loans to the stressed borrower or related entities closer to the repayment date of the earlier loans. 
• Extending loans to wilful defaulters to keep them out of the defaulters’ books.

Does evergreening crowd out good borrowers? 

• Weak firms increase leverage by borrowing through related parties from weak banks, but decrease real investment.
• Such resource misallocation supports the crowding-out effects ascribed to zombies, according to an RBI paper on Zombies and the Process of Creative Destruction. 
• It results in credit being diverted to weak entities – which is ultimately diverted for other purposes or it becomes a bad loan – depriving the genuine credit needs of good borrowers.

Ways to stop evergreening:

Recommendations by PJ Nayak Committee to Review Governance of Boards of Banks:

• If significant evergreening is detected by RBI supervisors, it must mean that evergreening is wilful. Penalties should be levied through cancellations of unvested stock options and claw-back of monetary bonuses on officers concerned and on all whole-time directors.
• The Chairman of the audit committee be asked to step down from the board.
• The primary defence against evergreening must however come from the CEO, the audit committee and the board.

News Source: Indian Express