How RBI blocked evergreening of overseas loans
In order to curb bad loans, the central bank tightened rules on bank guarantees to overseas units of Indian firms
The fact that India’s banking regulator is annoyed with the rising bad loans of banks is well known. In the past few years, the pile of bad assets as well as restructured loans—both through the so-called corporate debt restructuring, or CDR, platform as well as bilateral deals—has ballooned. The Reserve Bank of India has been goading banks for faster dfacetection and resolution of bad assets.
Now, the regulator seems to have shifted its focus to the overseas subsidiaries and branches of Indian banks that have been evergreening loan accounts to prevent them from turning bad. Once a loan turns bad, a bank needs to set aside money to provide for such a bad loan and this hits its profitability. Evergreening refers to the practice of giving a fresh loan to repay an old loan.
On Tuesday, RBI barred banks from issuing stand-by letters or credit guarantees as well as letter of comforts on behalf of Indian companies’ overseas ventures for purposes other than their normal business. “It has been observed that banks are extending non-fund based credit facilities like guarantees” on behalf of Indian companies’ overseas outfits “for purposes which are not connected with their business,” it said.
There has been rampant misuse of this facility by banks to keep their overseas books clean. In the past year, several companies in businesses such as infrastructure, logistics, shipping and power (typically, the kind that have a lot of debt on their books) have used this facility. At this point, one infrastructure company was negotiating hard with a large private bank for guaranteeing a loan of a few hundred million dollars.
How do the banks misuse this facility which RBI started offering in May 2007? Well, it’s fairly simple. Suppose Bank A gives a three-year $500 million loan to the overseas subsidiary of an Indian company through its overseas branch. If the borrower fails to pay back, then the loan turns bad and the bank’s overseas branch has to provide for it. Since the overseas business is not too big, a bad loan of $500 million hits the bank’s overseas operations hard.
As it cannot give a fresh loan to the company directly to pay off the old loan, the parent bank in India offers a guarantee based on which the company raises a fresh loan from another bank to pay back the old loan. This way, the overseas branch of the bank gets back its money and the risk gets transferred to its parent. This is evergreening through an indirect route.
Kudos to RBI for plugging the loophole which banks have been using ingeniously.
Banker’s Trust Realtime is a frequent blog by Tamal Bandyopadhyay, who writes a popular weekly column Banker’s Trust.
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