CSIP: PRELIMS BOOSTER SERIES-387 Economics
Evergreening of Loans
Context
The Reserve Bank of India (RBI) has strengthened regulations for Regulated Entities (RE), including banks and financial institutions, to curb the evergreening of loans through investments in Alternative Investment Funds (AIFs).
Evergreening of Loans
Evergreening of loans is a practice where lenders give new or additional loans to borrowers who are already struggling to repay existing loans. This essentially kicks the can down the road, postponing the Inevitable default and masking the true health of the loan portfolio.
How does it Work?
- A borrower takes out a loan and makes regular payments initially.
- However, due to unforeseen circumstances, the borrower starts falling behind on payments.
- Instead of classifying the loan as a non-performing asset (NPA), the lender might provide the borrower with a fresh loan.
- This fresh loan money is then used to repay the outstanding interest or principal on the original loan, making it appear like the borrower is back on track.
- This cycle can continue for some time, with the borrower perpetually juggling multiple loans and never actually getting out of debt.
Why is evergreening bad?
- It masks the true financial health of the lender: By keeping bad loans off the books, evergreening makes the lender’s financial situation appear better than it actually is. This can mislead investors and regulators, creating systemic risks.
- It prolongs the borrower’s suffering: Instead of facing the consequences of default and potentially restructuring their debt, borrowers trapped in evergreening end up accumulating more and more debt, making it even harder to escape the cycle.
- It discourages responsible lending: When lenders know they can evergreen bad loans, they may be less careful about who they lend to, leading to an increase in risky lending practices.
Example
- Zombie lending: This refers to the practice of continuously rolling over or refinancing loans for distressed borrowers, even though they are unlikely to ever repay them.
- Window dressing: This involves taking temporary measures to improve the financial appearance of a company before the end of a reporting period, such as selling off assets or delaying payments to suppliers.
Evergreening is a complex issue with no easy solutions. However, by being aware of the risks and taking appropriate measures, lenders and regulators can work together to create a more stable and sustainable financial system.