Zombie lending, forbearance, evergreening: Economic Survey talks about lending perils in India

The Economic Survey 2020-21 has highlighted the perils of banking forbearance, zombie lending, and ever-greening of loans, as the country tries to cope with a banking crisis, that has lasted over two years.

What is forbearance?

During the 2008 financial crisis, the government relaxed provisionary requirements for banks to help borrowers’ tide over temporary hardship caused due to the crisis and prevent a large contagion. However, the forbearance (delaying foreclosure) continued even after the economic recovery, resulting in detrimental consequences for banks, firms, and the economy.

"The forbearance period witnessed an increase in lending to unproductive firms, popularly referred to as zombies," the survey found.

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What are Zombies?

Zombies are typically identified using the interest-coverage ratio, the ratio of a firm’s profit after tax to its total interest expense. Firms with an interest-coverage ratio lower than one are unable to meet their interest obligations from their income and are categorized as zombies.

The share of new loans to such firms increased from 5% in 2007-08 to a whopping 27% in 2014-15, the Survey said.

There is another motive for undercapitalized banks to engage in lending to poor quality firms: to protect their already depleted capital, it adds.

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Zombie Lending

"One way of ever-greening loans is lending a new loan to a borrower on the verge of default, near the repayment date of an existing loan, to facilitate its repayment. Such transactions go undetected as banks are not required to disclose them, unlike restructurings that warrant disclosures," the Survey explains.

To further disguise their lending to distressed borrowers, banks may direct credit to other healthy firms in the business group to which those borrowers belong, the survey said.

"Although the loans appeared healthy in banks’ loan books, they were given to a business group under distress. This demonstrates that banks engage in proxy zombie lending by lending to healthy borrowers of a distressed group, who could ultimately divert the loans to other distressed firms within the group," the survey explains.

** Dirty Dozen are the 12 large firms identified by the RBI that contributed to 25% of overall NPAs in 2016-17, i.e. INR 3.45 lakh crores (Economic Survey)

This commentary may be the result of the fact that RBI had to bail out two full-fledged private banks within a span of 10 months last year. In the post-mortem of India's biggest banking failure by analysts, the fall of YES Bank, the evergreening of loans has been one of the primary reasons for India's banking crisis.

"Therefore, it is important to consider a business group as a whole, instead of individual firms, for a more robust estimate of zombie lending," the survey noted.