The last round of forbearance, undertaken after the global financial crisis of 2008, should have ended in 2011. “The roots of the present banking crisis go back to the prolonged forbearance policies followed between 2008 and 2015," the survey said. It resulted in “unintended and detrimental consequences for banks, firms, and the economy.”
Gross NPAs increased from 4.3 per cent in 2014-15 to 7.5 per cent in 2015-16 and peaked at 11.2 per cent in 2017-18. Early resolutions of banking crises should have limited the damage, but the RBI “dragged its feet in biting the bullet.” The consequent result was a further exacerbation of the situation.
The banks took advantage of a relaxed provisioning requirements and window-dressed their books by restructuring loans of unviable entities. The inflated profits were paid back to the owners as dividends, including to the government, rendering the banks severely undercapitalised. This further led to risky lending practices, including lending to ‘zombies’, a practice where good money is given to keep bad debts look healthy.
During the forbearance window, the proportion of firms in default increased by 51 per cent after their loans got restructured, against just 6 per cent increase in the pre-forbearance time."Forbearance thus helped banks to hide a lot of bad loans.”
By the time forbearance ended in 2015, restructuring had increased seven times while NPAs almost doubled when compared to the pre-forbearance levels, the report noted.
The AQR was done subsequently, but “could not bring out all the hidden bad assets in the bank books and led to an under-estimation of the capital requirements. This led to a second round of lending distortions, thereby exacerbating an already grave situation.”
The fact that the AQR exercise “significantly under-estimated the full extent of NPAs," and failed to prevent ever-greening in banks was evident by the recent events at Yes Bank and Lakshmi Vilas Bank, it said.
"Had the AQR exercise detected evergreening, the increase in their reported NPAs should 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 ever-greening by these banks.”
The RBI also assumed faultily that private banks would be able to raise capital after the clean-up, according to the report. Undercapitalised banks cut down on their lending sharply, which negatively impacted even the healthy borrowers who had to cut down on their investments and capital expenditures.
The AQR, therefore, “must account for all the creative ways in which banks can evergreen their loans.” The banking regulator needs to be more equipped in the early detection of fault lines and must expand the “toolkit of ex-ante remedial measures,” it said.
There should be mandatory capital infusion after cleanup of bad debts, and the quality of governance should be improved. "Ever-greening of loans by banks as well as zombie lending is symptomatic of poor governance, suggesting that bank boards are “asleep at the wheel” and auditors are not performing their required role as the first line of defence.” If evergreen is discovered later, such auditors should be penalised, suggested the report.