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The last asset quality review (AQR) of banks in 2015 failed to detect lenders evergreening loans outside the formal restructuring process, the Economic Survey said, calling for a fresh AQR immediately after the covid-19 forbearance ends. According to the survey, the effects of such evergreening manifested later at Yes Bank and Lakshmi Vilas Bank, two private lenders where bad loans built up to a level where they had to be rescued by the central bank.

“Had the AQR exercise detected evergreening, the increase in their reported NPAs (non-performing assets) should have been in the initial years of AQR. Our analysis clearly shows most NPAs were lent and restructured during the forbearance phase. Hence, the RBI audit missed some severe cases of ever-greening by these banks," the survey said.

Evergreening refers to banks extending fresh loans to delinquent borrowers to help them repay existing loans, hiding the true extent of bad loans. Convinced that only a “deep surgery can discover and root out bad loans", RBI under former governor Raghuram Rajan ordered a thorough inspection of banks’ books. The AQR led to a significant rise in bad loan recognition, higher provisions and witnessed lenders reporting quarterly losses.

The survey said another clean-up of bank balance sheets is necessary when the ongoing forbearance is discontinued. It said that while the last AQR exacerbated the problems in the sector, it does not mean another round should not be conducted.

“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gets accentuated during the forbearance regime, an AQR exercise must be conducted immediately after the forbearance is withdrawn," it said.

RBI allowed lenders to offer a six-month moratorium between March and August as a relief measure against the onslaught of covid that left millions without jobs and incomes. Besides, a pending case in the Supreme Court seemingly allowed an informal extension of the moratorium even after 31 August. Bankers believe retail and small business loans will come under a lot of stress in the coming months.

The survey suggested the next AQR must consider all the ‘creative’ ways in which banks can evergreen loans. “In this context, it must be emphasized that advance warning signals that do not serve their purpose of flagging concerns may create a false sense of security. The 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.

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