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30th May 2023 (7 Topics)

Evergreening of Loans

Context

The RBI issues a warning against "evergreening" loans, when banks employ cutting-edge techniques to hide the true situation of stressed loans.

About

What does evergreening of loans mean?

  • The process of evergreening of loans, a form of zombie lending, is a temporary fix for a bank.
    • 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, which is essentially the rolling over of debts of unviable borrowers that would have otherwise defaulted.
  • This is a form of misgovernance, as bad loans are made to look good many a time by additional lending to troubled borrowers.

When do banks evergreen loans?

  • Restructuring is often used by banks to 'evergreen' problem accounts to keep reported NPA levels low.
  • This was allowed between 2000 and 2014, but with the enactment of the bankruptcy code, evergreening has declined.
  • An accommodative monetary policy creates an enabling environment for weak banks to evergreen loans to zombies, leading to a jump in NPAs.

What is the main Concern?

  • The process of evergreening of loans, a form of zombie lending, is typically a temporary fix for a bank. If an account turns into a non-performing asset (NPA), banks are required to make higher provisions which will impact their profitability.

How can evergreening be stopped?

  • The primary defence against evergreening in a bank must come from the CEO, audit committee and board.
    • If significant evergreening is detected by RBI supervisors, penalties should be levied through cancellations of stock options and claw-back of bonuses, and the Chairman of the audit committee should step down from the board.

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