Inefficient bank boards and the failure of auditors to understand the ‘ever-greening’ problem added to bad-loan mess, says the survey.
The Economic Survey 2021 has come down heavily on the poor governance structure in banks, blaming it for the bad loan mess in the system.
The inefficiency of the bank boards and the failure of auditors to understand the problem of "ever-greening" contributed to the mess, the government's annual pre-budget survey released on January 29 said. Apart from re-capitalising banks, it is important to enhance the quality of their governance.
Ever-greening refers to the practice of banks giving fresh loans to the same borrower to enable them to pay up the old loan and, in turn, hide the actual stress in the banking system. This leads to systemic problems at a later stage.
“Ever-greening of loans by banks as well as zombie lending is symptomatic of poor governance, suggesting that bank boards are “asleep at the wheel” and auditors are not performing their required role as the first line of defence. Therefore, to avoid evergreening and zombie lending following the current round of forbearance banks should have fully empowered, capable boards,” the survey said.
Also read: Economic Survey 2021: Yes Bank, LVB events show RBI audits failed to catch 'ever-greening'
“Sound governance is a key metric to ensure that banks do not engage in distortionary lending post capital infusion. The regulator may consider penalties on bank auditors if ever-greening is discovered as part of the toolkit of ex-ante measures. This would thereby create incentives for the auditor to conduct the financial oversight more diligently,” the survey said.
There have been several cases where the failure of boards and auditors has been cited as the reason for the worsening stress in the banking system. Yes Bank and Lakshmi Vilas Bank (LVB) are two such examples where poor governance led to financial instability and, later, hurried bail-outs. Investors have suffered in both these cases.
Yes Bank was bailed out by a clutch of banks in March after the private lender faced a crisis due to alleged fraud and careless lending by the previous promoters. This happened after the RBI announced a reconstruction scheme.
In the case of LVB, too, the RBI facilitated a rescue deal by asking DBS Bank to take over LVB.
“While the learnings from the previous episode must be employed to avoid a recurrence, ex-post analysis of complex phenomena must be disciplined by the insights,” the survey said, adding, “specifically, to enable policymaking that involves exercise of judgement amidst uncertainty, ex-post inquests must recognise the role of hindsight bias and not make the mistake of equating unfavourable outcomes to either bad judgement, or worse, malafide intent.”
Bolster recovery mechanism
The Economic Survey has also called for the legal infrastructure to strengthen the recovery of loans. The Insolvency and Bankruptcy Code (IBC) has provided the de jure powers to creditors to impose penalties on defaulters.
“However, the judicial infrastructure for the implementation of IBC–comprised of debt recovery tribunals, National Company Law Tribunals and the appellate tribunals must be strengthened substantially,” the survey said.
The creation of IBC mechanism has helped Indian banks to address resolution of some of the large corporate NPA cases. But, the success of the IBC has been limited to only a few large cases. The DHFL, the first case of a finance companies admitted to IBC, has almost reached a resolution with the Piramal Group winning the bid to take over the firm. NCLT is yet to make an announcement on this.