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Not so Evergreen

In this week's FinMail we will understand what's going on in IndusInd Bank that recently pushed its stock price down by more than 10%. We will understand what loan evergreening is and how Banks use this to hide their bad loans.

The Story

On November 5, 2021, Economic Times reported that several people, including some of the senior employees of IndusInd Bank's subsidiary Bharat Financial Inclusion Ltd (BFIL), have turned into Whistleblowers and have reported to the RBI about the lapses in governance and accounting norms in order to do 'evergreening' of about 80,000 loans amounting to thousand crores rupees and that too without the consent of the customers.

The group of whistleblowers also alerted RBI that if the practice of evergreening the loans is not quickly rectified, BFIL (subsidiary) would risk the capital of its parent company IndusInd Bank as well. For the uninitiated, a whistleblower is a person/s who is aware of the wrongdoings or illegal activities happening in an organisation and reports it to the concerned authority (anonymously of course).

Now, these are some serious allegations that were made to the RBI and to the board of IndusInd Bank, following which the share price of IndusInd bank fell as much as 12% intraday and closed at 10% lower than the closing price of the previous day. And it has kept falling since then throughout the week.

Of course, it is the news that would concern the shareholders of the company. And of course, no bank would ever 'admit' that it has been evergreening the customer's loans that too without their consent.

But hey, what is this loan evergreening we are talking about? How banks could use it to hide their bad loans? And how it can become a potential threat to the bank's very existence? All in this week's FinMail, coming right up.

Loan Evergreening and how bad it is:

Loan Evergreening is the process where banks (lenders) give out more loans to the borrower who is on the verge of missing their loan repayments. In simple terms, banks give out new loans to borrowers who are irregular in the payments of old loans; so that the borrowers don't classify as defaulters or NPAs. So if you see, banks provide new loans to help repay the loans it provided earlier.

And definitely, it is the wrong thing to do. Because essentially loan evergreening is done by lenders to hide their NPAs and make their loan book look good and healthy from the outside; no matter how weak the structure is from the inside. And when it is proven that the bank was indeed evergreening the loans, the reputation of the bank itself comes at stake and with that depositors' money as well.

Summary of the happenings at IndusInd Bank

As per the report published by Economic Times, a group of whistleblowers reported the improper practices happening in the IndusInd Bank's subsidiary BFIL. The report further mentioned that on 14th October, RBI received a complaint from a different whistleblower about the process lapses in the extension of loan contracts, loan disbursement, and accounting principles.

And the report also revealed that about a month before the 14th October complaint, the executive chairman of BFIL who was also the former CEO of the company, Mr. M Rao resigned while stating that, he is aware of the 80,000 loans disbursed to the customers without their consent. He also stated that to him it doesn't feel like a process lapse from BFIL's end but a deliberate act to hide the NPAs.

Responding to the allegations of the whistleblower, the bank denied that it carried evergreening of the loans and 'clarified' that the loans were disbursed because of a Technical Glitch. Obviously, no bank would accept the allegations of loan evergreening. Although it accepted that the 84,000 loans were indeed disbursed to the customers without their consent because of a "Technical Glitch" on their end. (Technical Glitch is basically 'Javed Jafri' in Dhamaal in situations like this)

The bank clarified that it had overgone a technology upgrade in their system which required biometric verification for customer approval and if the verification is failed, an OTP is sent to the customer to seek approval. On May 21, 2021, a bug in the system led to the OTP verification being skipped which led to the loan disbursements without the approval of customers.

Yes, the shareholders didn't buy the bank's side of the story and it led to the share price of IndusInd Bank's falling more than 12% intraday on Monday. As per the reports, IndusInd bank's market cap fell by about ₹9400 Crores ($1.3 Billion) in value. What caught the eye of the experts is that in the press statement of IndusInd, no one is held responsible for the supposed technical glitch in the update. And that the bug appeared about a month after the upgrade was made to the system. But...

There's a process as per the RBI guidelines that the companies present in the financial sector have to follow while upgrading their systems which is to test the upgrade internally and get the required approval within the organisation, get its in-depth audit done, and then launch it on a pilot basis for an initial period of time. Only after going through all the checks, the system is deployed for commercial use, and there too it is actively monitored. And this is what is suspicious because the bug that the bank is talking about couldn't have gone unnoticed during the upgradation process.

Even if the statement of the bank is to be believed for once, the mess is not widely spread as the outstanding amount of the loans from the said portfolio only amounts to ₹34 Crores and 0.12% of the overall loan portfolio of BFIL. The report suggested that the whistleblowers are believed to be from the top management of BFIL and the statement given by the executive chairman of BFIL while resigning certainly raises the red flags about the situation at the IndusInd's subsidiary. All it remains is what the RBI has to say on the current matter and whether or not would RBI carries an investigation on the said matter.

But what we want to discuss before we conclude is that while all of this was happening since May 2021, (at least that's the earliest date we know) why all of these remain hidden from the eyes of the public at large till the most recent?

And this is not happening for the first time. India has not been new to the mishappenings in financial institutions like Yes Bank, Lakshmi Vilas Bank, IL&FS, DHFL, ICICI Bank, PMC Bank and many others. So what is the thing in banks or financial institutions that leads to such mishappenings going unnoticed from the people's eyes until it actually happens or comes to notice untill it's too late?

The problem with the Indian Banking Industry

If you look at it, banks don't have a complex business model rather a simple and straightforward one. Accept deposits at a certain rate of interest (say 3% for instance) and provide some portion of deposits as loans at higher interest rates (7% for instance) and the difference between these two is revenue for a bank. Pretty simple, right? Then what is the reason for us ending up at such failures of the system again and again?

Complexities in analysis of bank's fundamentals

First of all, analysing the fundamentals of any company (other than banks) is a complex task, you have to go through a long process of anything and everything that company does and is going to do. It includes understanding the vision & mindset of the company's promoters, board of directors, key management, etc., the company's product/services, market environment, regulations, policies and a whole bunch of other stuff along with the financials.

And when it comes to analysing a bank, things change drastically. The fact that the company is involved in the 'money' business makes things even more complex. It requires detailed knowledge and experience to be able to read between the lines of what a bank says or does & what it actually shows in its books.

The history of the banking industry says that even though one could acknowledge that a particular bank is doing fine but you never know what's going on behind the curtains. And what's even more confusing is that there are instances where banks that eventually failed had shown exponential growth in their business (out of their bounds) just before it failed. There are many examples of banks & NBFCs that have gone down hiding their 'Kaali Kartoot' for years making fool out of public largely. Things can be manipulated, we know it. Banks live by it.

In some cases, there were signs reflecting that something was fishy while in some things came out suddenly out of nowhere like in the IndusInd Bank. Though it is not relatively major misconduct but it does make one thing clear that one might be fully aware of the undertakings of a bank but some things (mostly bad) stay with the insiders.

Our country has witnessed the failure of many banks & NBFCs and they are not the only parties to be blamed here but also the RBI (swallowing the hard pill). These failures raise some serious question marks on the industry regulator. Because, unlike other businesses/industries, in banks, the general public is the stakeholder at large and it does hurt the confidence of people over the banking industry and that too in a country where the financial inclusion is significantly lower. RBI does conduct the annual inspection of banks & NBFCs but you see, the things which are meant to be kept hidden from the stakeholders are kept hidden even though inspection is conducted.

This being said, we are not saying every bank is conducting unlawful & unethical activities (of course not) but we are only pointing out the fact that... you never know!

Things to take care of by us as an Investors

Banks are at the center point of growth in the developing country. So whenever you're Investing in a bank or NBFC, do all the due diligence you can, keep your senses open, study about the top-level management, keep a sharp eye on the bank's loan book. It matters a lot that to whom the bank is lending - corporates, retailers, etc., For instance, if a company (say Voda-Idea) fails then it will also hurt those banks from which it had borrowed money (here SBI, Yes Bank, IndusInd Bank, etc.) like a chain effect. Also, another important thing is to keep monitoring NPAs and some other useful ratios to understand banks' or NBFC's financial health.

Though the numbers can be manipulative, do factor in the tini tiny probability of it being doing something mischievous. Well, That's the way it is.

So that is it for this week's FinMail. Keep learning. We will see you next week.


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