Ever-greening of Bank Loans in India

“One can put lipstick on a pig but it doesn’t become a princess.”

Raghuram Rajan, Governor, Reserve Bank of India, on the rampant practice of ever-greening of loans by banks in India

 

 

 

 

 

Ever-greening of bank loans is a prevalent phenomenon in India. It represents the tendency of banks to

avoid, rather delay the recognition of loans made by them, as ‘bad’ or irrecoverable even in the presence

of information supportive of potential non-recovery. Often, instead of writing off loans as bad, fresh loans

are granted to partially repay the earlier one and thus to cover up the truth. By keeping the loan account

on the books, the bank is able to justify its decision of not recording an expense. Simply put, ever-

greening is the denial of bad news by banks, until it can no longer be concealed.

Ever-greening has the appearance of a short-run win-win situation for both contracting parties – the

banker does not have to take an earnings hit and the borrower often gets a new lease of life. Banks often

justify this behavior by arguing that fresh financing increases the likelihood of poorly-performing

borrowers bouncing back and regaining financial health. Anecdotal evidence suggests otherwise. Crippled

borrowers often go bankrupt and plead for a Corporate Debt Restructuring (CDR), thereby directing

affecting lender profitability as they now have to write off an even larger loan.

Why don’t banks ‘provide’ for potential losses arising out of non-recovery based on past expectation?

The answer is simple – banks are required to put aside a certain percentage of their profits each year

towards a reserve/ provision for bad debts, representing a portion of loans that are unlikely to be realized.

The graduated structure of provisioning requirements for Indian banks reaches its maximum at 100

percent of the book value of Non-Performing Assets (NPAs), representing loans that have remained

inactive for a fairly long time. However, since this charge must come out of a bank’s profits, managers

attempt to minimize the provisioning requirements by avoiding the recognition of loans as NPAs. Hence,

the problem. This tendency is quite clear since Indian banks have the lowest Reserve Coverage Ratios in

Asia , rendering them more prone to financial turbulence.

Another closely linked phenomenon is that of unscrupulous securitization of bad loans (NPAs) by banks

to Asset Reconstruction Companies (ARCs). ARCs have gained a lot of importance in the recent past.

Indian banks are increasingly approaching them to off-load risky and potentially-bad loans from their

balance sheets. Banks sell and ARCs purchase NPAs from banks at a price, along with all risks and

responsibilities related to recovery of these loans as they fall due. Since ARCs are often able to recover

only a portion of loans purchased, they traditionally buy bank receivables at hefty discounts (called

‘haircuts’), representing up to 95% of loan value. It is estimated that the sale of NPAs to ARCs

increased from Rs. 80 billion in 2012-13 to 270 billion within a year.

Selling receivables to the ARC’s does not solve the problem, partly because of the way the deals are

settled. ARC’s frequently pay only about 5 percent of the sale value of loans purchased in cash and the

balance in Securities Receivable (SRs). These SRs continue to remain on the books of the lender (the

original bank) until the loan is realized. This means that now the lender’s risk is not mitigated, but

‘shared’ with the ARC to whom the loans are sold. One large loan goes bad and it sweeps away the

fortunes of all three – the failed borrower, the ARC and the lender who holds worthless SRs on its books.

In the Indian context, there is no dearth of examples of bank loans that were rolled over again and again

in anticipation of borrower recovery. However, in most cases, the lenders were proven wrong. The most

notable examples here are those of Hotel Leela and ABG Shipyard. In case of the former, Indian Overseas

Bank, Syndicate Bank and the Bank of India have lent significant amounts to the company. Owing to

consistent poor profitability and liquidity, the bankers are not very keen on granting fresh loans to Leela

unless a CDR is agreed upon. Even if a CDR finally happens, it appears likely that it shall be bankers who

will have to take a hit by relaxing the interest terms and haircuts. Similarly, ABG Shipyard has loans of

Rs. 11,500 Crores involved in a potential CDR. Lenders ICICI and State Bank of India appear skeptical

about promoter Rishi Agarwal’s plans of restructuring.

Ultimately, ever-greening appears to be a not-so-healthy practice for Indian banks. The Indian financial

markets have seen it all – interest rate fluctuations, massive speculation in stock markets, booms and

crashes, to say the least. An economy-wide downward spiral is the last thing we would want to see now.

On that note, a piece of advice to Indian banks – a stitch in time saves nine!

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