Be wary of zombie lending: CEA

Indian lenders must closely watch their asset quality to avoid a repetition of the unsustainable lending that occurred following the financial crisis of 2008-2009, said chief economic adviser (CEA) K. V. Subramanian.

“One of the other key aspects that must be kept in mind is that forbearance is necessary at this point in time, but the previous episode in 2008-09 illustrates very well the kind of zombie lending that continued, evergreening that happened during that time, which came back to bite three-four years later,” said Subramanian. He was speaking at industry body Ficci’s non-banking financial company (NBFC) Summit on Thursday.

Zombie lending refers to the practice of providing credit to entities that do not have the capability to repay. While this inflates credit growth, loan defaults haunt financial institutions at a later stage.

He said that all financial institutions, and their boards, in particular, should keep a very careful watch on lending. “For instance, lending to firms with interest coverage ratio (ICR) of less than one increased significantly after 2008-09, and that is the kind of thing that must be watched,” said Subramanian. ICR is the ratio of a company’s earnings before interest and tax to interest expenses and is a measure of the debt-servicing capacity.

Non-bank financiers, he said, must keep in mind the interconnected risk which arises when mutual funds invest in their commercial papers (CPs).

“At this point in time, while the regulators are mandated to monitor these things, at an individual level, every NBFC needs to monitor its rollover and interconnected risk as well. I think it is in times like these that the prudential measures must be taken by each NBFC to ensure that risks do not mount,” he said.