Under-capitalisation of banks and the pernicious phenomenon of zombie lending (lending without due diligence) or ever-greening (not recognising sticky assets) that led to the bad loan crisis in Indian banks has been blamed on the UPA and its cohorts who provided regulatory forbearance, thereby allowing lenders to conceal the magnitude of the problem.

The Economic Survey 2020-21 cited this history as it made the case for implementing such reliefs as only a short-term or emergency measure and not to extend them after the economy recovers.

The Survey also called for another round of asset quality review to clean up bank balance sheets after the withdrawal of the forbearance given by the RBI to tide over the Covid-19 pandemic.

Regulatory forbearance is offered in the form of relaxing the norms for restructured assets. The relaxation may see these assets no longer being classified as stressed loans.

The annual document, which devoted a chapter to regulatory forbearance, said the global financial crisis of 2008 had sparked the need for such a relaxation.

However, the forbearance continued for seven years though it should have been discontinued in 2011, when GDP, exports, industrial output and credit growth had all recovered significantly. It added that amid the relaxed provisioning requirements, banks exploited the forbearance window to restructure loans even for unviable entities.

The inflated profits were then used by the lenders to pay increased dividends to shareholders, including the government in the case of PSU banks. Consequently, banks became severely undercapitalised. This fostered risky lending practices.

The views expressed in the Survey comes at a time when the Supreme Court has directed banks that accounts which were not declared non-performing asset (NPA) till August 31, 2020 will not be declared as a bad loan till further orders. Moreover, the RBI had also announced a one-time restructuring scheme (which ended on December 31, 2020) under which banks can restructure assets without classifying them as bad loans.

Here, the Economic Survey went on to say that forbearance represents emergency medicine that should be discontinued at the first opportunity when the economy exhibits recovery and that it should be used as ``a staple diet that gets continued for years’’. It also issued a veiled warning by using a quote from George Santayana as an epigraph to the chapter: “Those who do not learn from history are condemned to repeat it.”

According to the Survey, by the time forbearance ended in 2015, restructuring had increased seven times while NPAs almost doubled when compared to the pre-forbearance levels. This led to the RBI, under former governor Raghuram Rajan initiating an AQR. However, this review could not detect ever-greening of loans or bringing out all the hidden bad assets in the bank books, ultimately leading to episodes like that of Yes Bank and Lakshmi Vilas Bank.

``A clean-up of bank balance sheets is necessary when the forbearance is discontinued... While the 2016 AQR exacerbated the problems in the banking sector, the lesson from the same is not that an AQR 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 withdraw’’, the Economic Survey suggested.

It added that if done in the near future, the AQR must account for all the creative ways in which banks can ever-green their loans. Further, the regulator may consider penalties on bank auditors if ever-greening is discovered. In banking parlance, ever-greening happens when a bank gives fresh loan to a defaulter or a stressed borrower who then repays the old loan.