Evergreening of loans still remains a bane of banking

livemint.com:

RBI) cautioned against the evergreening of loans. In its supervisory role, RBI had noticed innovative methods adopted by certain banks to conceal the true stressed nature of loans. For instance, two banks might get into an arrangement of sale and buyback of troubled loans from each other to erase the history of a stressed loan and start afresh.

Or a loan might be extended to a related entity of a stressed borrower, which in turn may be used to prevent the true picture from being exposed. RBI also found that after objecting to one method of evergreening, the bank resorted to a newer one. Evergreening is an euphemistic expression that means giving a fresh loan to avert default on an existing one.

It is borderline unethical, if not outright illegal. Banks have an incentive to hide stressed loans, because once classified as such, they have to provide for losses, which reduces profit. The governor pointed out that such examples of evergreening were symptoms of a governance failure, especially of the audit committees.

The ink has not dried on the governor’s speech, when comes another warning. RBI has barred banks from investing in Alternate Investment Funds (AIF) that in turn bail out stressed entities already indebted to the same bank and near default. This is yet another innovative way of evergreening.

All kosher, since no laws were being broken, until this latest move. AIFs have light-touch regulation from the Securities and Exchanges Board of India (Sebi) since they pool investor funds into non-traditional assets such as real estate, hedge funds and derivatives. Unlike mutual funds, the beneficial owners of AIFs are not always transparently known.