The Economic Survey 2020-21 has created a case for carrying out a fresh asset good quality overview (AQR) after the ongoing forbearances connected to Covid-19 come to an finish. Any such exercising need to be accompanied by a round of bank recapitalisation, it argued, as the preceding encounter of AQR only aggravated the issues produced by forbearance.
The Survey mentioned that forbearance represents emergency medicine that should really be discontinued at the initial chance when the economy exhibits recovery, not a staple diet plan that gets continued for years.
“Therefore, policymakers should lay out thresholds of economic recovery at which such measures will be withdrawn. These thresholds should be communicated to the banks in advance so that they can prepare for the same. Prolonged forbearance is likely to sow the seeds of a much deeper crisis,” the Survey mentioned.
In a subtle dig at the Reserve Bank of India (RBI), the Survey mentioned that the events at Yes Bank and Lakshmi Vilas Bank corroborate that the AQR did not capture evergreening carried out in methods other than formal restructuring. Had the AQR exercising detected evergreening, the boost in their reported non-performing assets (NPAs) should really have been in the initial years of the AQR.
“Our analysis clearly shows that most of the non-performing loans were lent and restructured during the forbearance phase. Hence, the RBI audit missed some severe cases of evergreening by these banks,” the Survey mentioned. The reality that each these banks had to be rescued by the regulator also goes against the RBI’s assumption that the private banks should really have been in a position to raise the needed capital immediately after the clean-up, the document mentioned.
Forbearance should really be accompanied by restrictions on zombie lending to guarantee a healthful borrowing culture, and a clean-up of bank balance sheets is essential when the forbearance is discontinued. While the 2016 AQR exacerbated the issues in the banking sector, the lesson from it is not that an AQR should really not be carried out. “Given the problem of asymmetric information between the regulator and the banks, which gets accentuated during the forbearance regime, an AQR exercise must be conducted immediately after the forbearance is withdrawn,” the Survey mentioned.
The overview need to account for all the inventive methods in which banks can evergreen their loans. In this context, advance warning signals that do not serve their goal of flagging issues may possibly build a false sense of safety, according to the Survey. The banking regulator wants to be more equipped in the early detection of fault lines and need to expand the toolkit of ex-ante remedial measures.
A clean-up unaccompanied by mandatory capital infusion exacerbates terrible lending practices, the Survey mentioned. “Expecting banks to get recapitalised on their own on account of economic recovery may not be prudent. Therefore, a clean-up exercise should be accompanied by mandatory recapitalisation based on a thorough evaluation of the capital requirements post an asset quality review,” it mentioned.
Apart from recapitalising banks, it is critical to improve the good quality of their governance. Evergreening of loans by banks as effectively as zombie lending is symptomatic of poor governance, suggesting that bank boards are “asleep at the wheel” and auditors are not performing their needed function as the initial line of defence. Therefore, to prevent evergreening and zombie lending following the present round of forbearance, banks should really have totally-empowered and capable boards.
“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 evergreening is discovered as part of the toolkit of ex-ante measures,” the Survey mentioned, adding that this would build incentives for the auditor to conduct the monetary oversight more diligently.
To allow policymaking that includes exercising of judgement amidst uncertainty, ex-post inquests need to recognise the function of hindsight bias and not make the error of equating unfavourable outcomes to either terrible judgement, or worse, mala fide intent.
Finally, the legal infrastructure for the recovery of loans wants to be strengthened de facto, the Survey mentioned. The Insolvency and Bankruptcy Code (IBC) has offered de jure powers to creditors to impose penalties on defaulters. However, the judicial infrastructure for the implementation of IBC – composed of debt recovery tribunals, National Company Law Tribunals, and the appellate tribunals — need to be strengthened substantially.