Last year, RBI Governor Shaktikanta Das talked to bank leaders about being too ambitious in growing and hiding bad loans. He stressed the importance of strong rules for running companies and pointed out cases where banks were not being honest about their troubled loans.
For example, two banks might trade troubled loans back and forth to make it seem like the loans were okay. Even after the RBI said no to one trick, the banks found new ways to hide their bad loans. This is what we call loan evergreening but let’s understand it in a bit more detail.
What is an evergreen loan?
An evergreen loan is a type of loan where you don’t have to pay back the principal amount you borrowed for a while. Unfortunately, banks use it as a tactic to cover up old potential default loans. So what they do is give new loans to cover up old ones that might not get paid back.
Why do banks indulge in loan evergreening?
Banks do it because if they admit a loan isn’t being paid, they have to admit they’ve lost money, which looks bad for them. Evergreening, which is like keeping a dead business alive, involves giving more money to someone who can’t pay back what they already owe, making it seem like everything is fine when it’s not.
How does loan evergreening work?
There are multiple ways through which loan evergreening happens. Some of the main ones are:
1) Giving new loans to troubled borrowers just before old ones are due.
2) Banks trading loans to dodge marking them as bad debts. This helps them prevent the rise of NPAs.
3) Getting strong borrowers to make deals with struggling ones to cover up their loan defaults.
However, since the RBI governor made that speech, a new and innovative way came up for the evergreening of loans. It was being done through Alternate Investment Funds.
Therefore, the RBI recently made a rule saying banks and other financial companies can’t invest in Alternative Investment Funds that lend money to companies they’ve given loans to in the past year. This is to stop companies from making bad loans look good by moving them around through these funds.
Sometimes, these companies invest in funds that then invest in debtor companies, helping them pay back the loans they owe, which makes it look like fewer loans are going bad on the books of the banks and financial companies. Hence, the RBI had to put a stop to it.
Also read: How will RBI’s risk weightage hike for unsecured loans impact borrowers?
Loan Writeoff Vs Loan Evergreening
Why don’t banks just write off the loans instead of resorting to evergreening? Well, this is because write-offs don’t mean that borrowers don’t have to pay their outstanding loans. Banks do this to tidy up their financial records and show their real financial situation.
On the other hand, evergreening loans means giving more loans to someone who can’t pay back what they already owe, making it seem like everything is fine when it’s not.
Conclusion
Considering the gravity of the situation, more focus needs to be given to evergreen loans. RBI should set clearer rules because the current ones seem to have affected AIFs greatly. Hence, instead of outright banning investments, the audit committees of banks and financial companies should decide if investing in certain funds is for real business reasons or just to cover up bad loans. A greater scrutiny will help both the parties involved and put a stop to loan evergreening.
Disclaimer: The above content is for informational purposes only.
