An Evergreeing Excercise That has Gone Unnoticed for Too Long

Context: Banks will have to enhance their audit toolkit to be able to detect indirect evergreening even a bad bank solution will not work if bad assets are not identified properly in the first place.

Key Features Evergreening of Loan

• Definition: it is an exercise in which banks revive a loan on the verge of default by granting further loans to the same firm.
• Consequences: Short term Reduction in reported defaults; Long term explosion in default rates.
• Process:
  • Direct: A troubled bank lends to a troubled borrower and is detectable with some effort.
  • Indirect: banks and firms use related entities to evergreen loans.
• Universal economic phenomenon: pattern has manifested in all major economies like US, European Union, Japan and India.

Phenomenon of Indirect Evergreening

• Use of related entities: When a borrower gets in trouble, banks help them by providing a subsequent loans to cover up (which is detectable).
  • However, banks try to bypass the regulatory oversight by providing loans through an intermediary party (shell firm) to cover their books (making it opaque)
  • Close to 5% of all large loans are indirectly evergreened, escaping the regulatory scrutiny.
• Preferable route over direct lending: as it has no immediate impact on decline in bank stock prices.
  • While bank stock prices react negatively to the renewal and/or restructuring of low-quality debt.

Adverse impacts of evergreening of loans:

• Evergreened loans end up in default: when either depositor realizes what is going on or when lenders cannot keep lending for want of capital due to economic shock/downturn.
  • E.g. Yes Bank (ranked No. 1 in terms of indirectly evergreened loans) saw an explosion of default rates and reached a point of technical failure.
• Wider economic implications and prevalence: trend is prevalent among many cooperative banks and non-banks and even goes beyond banking to industrial economy.
  • Rise in ‘zombie’ firms due to evergreening results in distortion of credit to start-ups.
  • Impact overall productivity and employment.
  • Halts process of Schumpeterian creative destruction due to inability of firms to obtain resources.