The Reserve Bank of India (RBI) Governor has recently addressed bank boards, expressing concerns over the strategies being adopted by banks, which include aggressive growth strategies and evergreening of loans. There is a significant emphasis on the necessity for robust corporate governance. Notable instances have emerged of concealing the true status of stressed loans.
Understanding Evergreening of Loans
Evergreening loans, a variant of zombie lending, involves extending new or additional loans to borrowers who are unable to repay their existing loans, thus concealing the genuine status of non-performing assets (NPAs) or bad loans. Methods used for evergreening loans can include the selling and buying back of debt instruments between two lenders to avoid classifying them as NPAs, and the use of internal office accounts to adjust borrowers’ repayment obligations. This practice often results in a false representation of banks’ asset quality and profitability, undermining credit discipline and eroding the trust of depositors, investors, and regulators.
The Concept of Non-Performing Asset (NPA)
A non-performing asset (NPA) refers to loans or advances that are in default or arrears on scheduled principal or interest payments. They are further segmented into three categories based on the duration of non-performance and the realizability of dues: sub-standard assets, doubtful assets, and loss assets.
Difference Between Loan Write-off and Evergreening
Loan write-offs are a means of eliminating bad loans from banks’ books after making adequate provisions. It doesn’t imply relief from repayment obligations for borrowers; rather, it helps to clean up the balance sheet of banks and reflect their true financial position. On the flip side, evergreening of loans involves extending new or additional loans to borrowers who struggle to repay their existing loans, effectively concealing the real status of NPAs or bad loans.
The Role of RBI
The RBI has advised banks against adopting over-aggressive growth strategies, warning them of the risks associated with such approaches. The central bank has also implemented measures to support the banking sector, including liquidity support, regulatory forbearance, and the establishment of an asset reconstruction company (ARC). Despite these measures, banks are urged to improve their risk management and governance practices.
Controlling Evergreening of Loans
The prevention of evergreening of loans can be achieved by enhancing risk assessment, promoting transparent reporting and disclosure, managing assets and liabilities efficiently, and complying with ESG norms. These approaches involve accurately assessing the creditworthiness of borrowers, disclosing loan portfolios transparently, assessing risks from maturity mismatches in assets and liabilities, adhering to environmental, social, and governance norms, and aligning with national and international goals on climate change and social welfare.
Recommendations of P J Nayak Committee
The Committee to Review Governance of Boards of Banks in India suggests penalties for banks involved in significant evergreening, including the cancellation of unvested stock options and clawing back monetary bonuses from concerned officers and whole-time directors. The Chairman of the audit committee must also step down from the board.
Previous Year’s Question from UPSC Civil Services Examination
In reference to public sector banking governance in India, consider the following statements: Capital infusion into public sector banks by the government has steadily increased in the last decade; the merger of associate banks with the parent State Bank of India has been effected to put public sector banks in order. Question: Which of the statements is/are correct? (2018; a) 1 only, b) 2 only, c) Both 1 and 2, d) Neither 1 nor 2. Answer: (b) Source: IE