Loan evergreening

Loan evergreening is a situation where banks provide loans to firms in order to ensure that firms keep repaying the existing (previous) loans. It is a concept related to zombie lending, broadly defined as lending to non-viable firms. Loan evergreening is a usual strategy to provide zombie lending, although it can be used in other circumstances.

In the recent years, there has been an increase in economic research trying to understand zombie lending and its consequences. Some blame zombie lending for the low productivity in some European countries. But less attention has been put on loan evergreening. Partly, this reflects an issue with data availability: it is easier to obtain data on firms (and hence proxy for which firms appear non-viable or very weak) rather than loan-level information.

And even if one has loan-level information, how do you detect loan evergreening? It is not like banks tell us why they are providing the loan. In many cases, they can provide loan evergreening before any problems, such as repayment delays, arise in the firm. This is an issue that we aim to tackle in a very recent paper with Cecilia Dassatti and Rodrigo Lluberas from the Banco Central del Uruguay.

Let’s imagine the following situation. A firm has an amortising loan, that is, a loan that has to be repaid periodically. But the firm is facing some trouble that may lead it to delay a loan repayment. Banks do not like that: they face increased credit risk—the firm might outright default—and, even more importantly, the regulator makes them provision for a potential loss. Provisions are very annoying for bankers: they come right before computing profits, and therefore they have a direct—negative, in this case—impact on bonuses.

What can the bank do? Well, the bank could provide a bullet loan to the firm—that is, a loan that is repaid only at the end of its maturity—so that the firm is not delayed. This seems a clear case of loan evergreening. But how can we detect such cases? A possibility is to flag every time a bank provides a bullet loan to a firm that already has an amortizing loan. However, firms might need bullet loans for reasons other than repaying the previous loan.

What about flagging situations in which the amount of a new bullet loan is very similar to the amount that the firm repays of the existing loan? For instance, a situation in which a firm receives $100 in the form of a bullet loan from a bank and repays in the same month $100 of the existing loan with the same bank. If we can detect these situations, it seems that we have found cases of loan evergreening.

But are these cases common? To answer this question, we compare the amount received in a new bullet loan with the amount repaid of the existing amortizing loan. We plot the histogram of the ratio in the figure below. As you can see, there is a spike of values very close to 1; that is, situations in which the two amounts are very similar.

From Dassatti et al. (2021)

In the paper, which is in its last minutes in the oven, we proceed to understand which bank characteristics are more linked to the provision of loan evergreening (spoiler alert: solvency), what happens with credit supply after engaging in this strategy, whether this strategy makes firms more or less likely to default, and what this means for other firms. But a post about the results will come once the paper is out.

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