Page 251 - ES 2020-21_Volume-1-2 [28-01-21]

234 Economic Survey 2020-21 Volume 1

7.41 In sum, the clean-up of bank balance sheets undertaken under the AQR exacerbated the
problems created by the prolonged period of forbearance. In terms of lending, being under-
capitalized, banks reduced lending to good borrowers while increasing lending to zombie
borrowers. For firms, the reduction in the supply of bank credit reduced their ability to invest.
Chopra, Subramanian, and Tantri (2020) compare the AQR with other clean-up programs and
point towards the necessity of having an explicit recapitalization program, forced or otherwise,
before entering such clean-ups.

IMPLICATIONS FOR THE CURRENT FORBEARANCE REGIME
7.42 The extensive, careful analysis of the regulatory forbearance and the resulting banking
crisis offers key learnings for the current regime of regulatory forbearance following the Covid
crisis. Finally:
(a) Remember that forbearance represents emergency medicine that should be discontinued
at the first opportunity when the economy exhibits recovery, not a staple diet that gets
continued for years. Therefore, policymakers should lay out thresholds of economic
recovery at which such measures will be withdrawn. These thresholds should be
communicated to the banks in advance so that they can prepare for the same. Prolonged
forbearance is likely to sow the seeds of a much deeper crisis. As well, forbearance
should be accompanied by restrictions on zombie lending to ensure a healthy borrowing
culture.
(b) A clean-up of bank balance sheets is necessary when the forbearance is discontinued.
Note that 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the forbearance is withdrawn.
(c) The asset quality review must account for all the creative ways in which banks can ever-
green their 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 banking regulator needs to be more equipped in the early detection of fault lines and
must expand the toolkit of ex-ante remedial measures.

(d) A clean-up unaccompanied by mandatory capital infusion exacerbates bad lending
practices. Expecting banks to get recapitalized on their own on account of economic
recovery may not be prudent. Therefore, a clean-up exercise should be accompanied by
mandatory recapitalization based on a thorough evaluation of the capital requirements
post an asset quality review.
(e) Apart from re-capitalizing banks, it is important to enhance the quality of their
governance. 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. Therefore, to avoid ever-
greening and zombie lending following the current round of forbearance banks should
have fully empowered, capable boards. Sound governance is a key metric to ensure that
banks do not engage in distortionary lending post capital infusion. The regulator may
consider penalties on bank auditors if ever-greening is discovered as part of the toolkit
of ex-ante measures. This would thereby create incentives for the auditor to conduct the
financial oversight more diligently.