MC Explains | Why the RBI is warning banks against evergreening loans

Why is this a concern?

Time and again, the RBI has asked banks to refrain from the practice of evergreening loans because by doing so, banks hide the actual stress on their books. Eventually, such stressed loans evolve into a crisis.

But, why did the governor highlight this issue now?

In his speech, Das said that the apex bank had identified certain instances where innovative ways were being used to conceal the real status of stressed loans. “...such methods include bringing two lenders together to evergreen each other’s loans by sale and buyback of loans or debt instruments; good borrowers being persuaded to enter into structured deals with a stressed borrower to conceal the stress," said Das.

Evergreening of loans happens when a bank tries to save a loan from defaulting so that it does not appear as a non-performing asset in its books. This is done by giving a fresh loan to a borrower to pay up an old loan.

"We have also come across a few examples where one method of evergreening, after being pointed out by the regulator, was replaced by another method," Das added.

"I have mentioned these instances,” Das said, “to sensitise all of you to keep a watch on such practices. Such practices beg the question as to whose interest such smart methods serve."

Why do some banks help borrowers engage in this practice?

By hiding the actual stress on their books, banks can show a healthier balance sheet to investors and depositors to attract more business and investments. Also, banks need to provision — set aside money — for bad loans. Such provisions impact the profitability of banks.

Is evergreening a new practice?

Not really. In the past, there have been instances when banks and non-banking financial companies engaged in evergreening of loans. Industry experts highlighted that the practice was rampant between 2013 and 2015 but the apex bank’s asset quality review (AQR), initiated under then governor Raghuram Rajan in 2015, forced banks to disclose all hidden bad loans on their books. The RBI has taken an extremely cautious approach since then.

Are there specific guidelines from the RBI on this subject?

The apex bank, in a master circular in April 2023, said that if banks are found to be evergreening loans and indulging in similar activities, they will be subject to stringent supervisory and enforcement actions.

“Under our supervisory, any action by lenders with an intent to conceal the actual status of accounts or evergreen the stressed accounts will be subjected to stringent supervisory or enforcement actions, including, but not limited to, higher provisioning on such accounts and monetary penalties,” said a statement from the central bank.

How did banks respond to the RBI governor’s comments?

Banks largely agreed with the observation from the RBI, saying some lenders indeed engage in evergreening of loans even today, and that the RBI governor’s comments would serve as a warning to wrongdoers.