RBI governor cautions against evergreening of loans: Are banks, corporates still window-dressing loans?

Source: The post is based on the article “RBI governor cautions against evergreening of loans: Are banks, corporates still window-dressing loans?” published in the Indian Express on 1st June 2023

What is the News?

Recently, the Reserve Bank of India (RBI) Governor raised red flags over banks adopting innovative methods for the evergreening of loans.

What is the evergreening of loans?

Evergreening loans is a practice of extending new or additional loans to a borrower who is unable to repay the existing loans. It is a form of zombie lending thereby banks concealing the true status of the non-performing assets (NPAs) or bad loans.

Banks delay the recognition of losses due to loan defaults and engage in evergreening. This is purely misgovernance. Some banks have even extended such loans to wilful defaulters to keep them out of the defaulters’ books.

What are the approaches used by banks for evergreening loans?

These include a) bringing two lenders together to evergreen each other’s loans by sale and buyback of loans or debt instrument, b) good borrowers being persuaded to enter into structured deals with a stressed borrower to conceal the stress, c) use of internal or office accounts to adjust borrower’s repayment obligations, and d) 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.

What does the evergreening of loans mean?

Evergreening loans can create a false impression of the asset quality and profitability of banks and delay the recognition and resolution of stressed assets.

Evergreeening loans can also undermine credit discipline and moral hazard among borrowers, and erode the trust and confidence of depositors, investors and regulators.

What is the difference between Loans written off and evergreening of loans?

Loan write-offs are a process of removing bad loans from the books of banks after making adequate provisions for them. Loans written off by the banks are removed from the NPA books and reflect banks true financial position.

Evergreening of loans, on the other hand, is a practice of extending new or additional loans.

How to stop the evergreening of loans?

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

The P J Nayak Committee or the Committee to Review Governance of Boards of Banks in India highlighted significant evergreening in banks and suggested a) levying penalties through cancellations of unvested stock options, b) claw-back of monetary bonuses on officers concerned and c) All whole-time directors, and the Chairman of the audit committee should be asked to step down from the board.