22-December-2023-Editorial

EVERGREENING OF LOANS STILL REMAINS A BANE OF BANKING

The practice of “evergreening” loans in India, wherein banks issue new loans to prevent defaults on existing ones, has drawn attention due to its potential risks to the banking system.

Understanding Evergreening of Loans:

• Evergreening involves the issuance of new loans to avoid defaults on existing ones.
• Banks resort to creative methods to conceal stressed loans, such as sale and buyback arrangements and extending loans to entities related to stressed borrowers.

RBI’s Findings on Evergreening Practices:

• Banks employ innovative methods, including sale and buyback arrangements and extending loans to related entities, to reset the history of stressed loans.
• Investment in Alternate Investment Funds (AIFs) is observed, indirectly perpetuating evergreening cycles.
• Usage of Commercial Paper (CP) by mutual funds, with banks redirecting CP proceeds for short-term funding, contributing to indirect evergreening.
• Rapid growth in unsecured loan assets of Non-Bank Finance Companies (NBFCs) raises concerns about underreported stressed loans.

Implications of Evergreening Loans:

• Misrepresentation of Loan Quality: Evergreening distorts the actual health of banks’ loan portfolios.
• Governance and Audit Failures: Evergreening practices signal lapses in governance and audit mechanisms within banks.
• Round-Tripping Challenges: Mutual funds’ investment in commercial papers, leading to round-tripping, escalates market concentration risk and may trigger a liquidity crisis.
• Regulatory Challenges: Ever-evolving evergreening methods pose challenges for regulators, especially the RBI, in ensuring financial stability.

Way Forward:

• Regulatory Oversight: Regulatory bodies like the RBI and SEBI need to enhance their oversight and address regulatory gaps to curb evergreening.
• Transparency in Reporting: Improving transparency in loan reporting, particularly in fast-growing sectors like non-bank financial companies, is crucial.
• Reinforcing Governance and Audit Processes: Enhancing governance and audit processes within banks is vital to maintain the integrity and stability of the financial system.
• Dealing with Cross-Regulatory Financial Instruments: Addressing the complexities of cross-regulatory financial instruments is essential for effective regulation.

Conclusion:

To combat evergreening practices in India, regulatory bodies must bolster their oversight, enhance transparency in reporting, and reinforce governance and audit processes. Tackling the complexities of cross-regulatory financial instruments is crucial for upholding the integrity and stability of the financial system in the face of evolving evergreening methods.