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