Haphazard credit disbursement that created irreparable holes in the balance sheet of erstwhile Apex Development Bank has exposed long-suspected counterintuitive practice of ‘evergreening’ of bad loans in the banking sector, which could contaminate and even bring down the entire financial sector.

The unethical and unprofessional practices of the development bank, which has now been merged with Nepal Credit and Commerce (NCC) Bank, were unearthed after the Central Investigation Bureau (CIB) of the Nepal Police arrested over a dozen people 10 days ago for their involvement in Rs1.5-billion scam related to the financial institution.

Those arrested were charged of misappropriating funds by issuing credit against substandard collateral.

Surprisingly, a loan restructuring directive approved by the board of directors of the development bank on September 13, 2015 had included a provision that enabled the management to disburse fresh loans to settle the outstanding credit, says an on-site inspection report prepared by the Nepal Rastra Bank (NRB), the banking sector regulator, a copy of which has been obtained by the Post.

This implies the bank’s board, whose job is to ensure good governance, had officially allowed the management to evergreen the loan book.

Evergreening takes place when banks provide additional loans to borrowers who are unable to service their debt on time. The additional loan is then used to repay the instalments of the outstanding loan. This is a counterintuitive practice because it prevents banks from issuing good loans, as available fund is diverted to borrowers holding low-quality loans. This creates a vicious circle and the financial institution ultimately finds itself in a position where it can no longer issue good loans, thus exerting pressure on capital adequacy ratio, an indicator to gauge the credit disbursement capacity of banking institutions.

Apex Development Bank was engaged in this malpractice for quite some time. This is evident from the practice of issuing loans to the same group of borrowers and diverting credit to the same group via other borrowers, according to the report, which was submitted to the NRB on January 12, 2017, or a month after the extension of final approval for merger between NCC Bank and Apex Development Bank.

One example of this malpractice is disbursement of demand and working capital loan of Rs50 million to Aditi Enterprises on October 16, 2015 on the back of overvalued assets. The loan was approved on the day the collateral valuation document was submitted to the bank, which is suspicious. The so-called demand and working capital loan was eventually not used for intended purpose. It was instead used to repay various parties, including Myanglung Housing, which had received Rs22.4 million, says the report. On the same day, Myanglung Housing had walked away with another credit of Rs70 million from the bank, adds the report.

Firms like Myanglung Housing, Aditi Enterprises, Arohan Housing and Agricultural Firm, Arunima Housing and Om Multipurpose Industries, according to the report, have either borrowed directly from the bank or were end users of many loans disbursed by the bank.

In another incident of similar nature, the bank had provided home loans of Rs125.4 million to 35 “dummy borrowers”, who transferred the funds to the accounts of Upen Newang, Pandav Nepal and Regan Karki, among others, says the report.

“This indicates money was being fed to limited number of borrowers, promoting evergreening of bad loans,” said a senior NRB official on condition of anonymity.

Apparently, the seeds of evergreening of bad loans at the institution were sowed long before Apex Development Bank came into existence. Apex was formed through merger between Royal Merchant Banking and Finance Limited, Rara Bikas Bank and Api Finance. At the time of the merger, credit of Rs1.15 billion disbursed by Royal Merchant was in a doubtful state. This was because loans were extended against substandard collateral and without evaluating assets pledged as collateral. Also, credit repayment capacity of borrowers was not assessed. And most importantly a number of fake borrowers were created to divert loans to Manoj Bhetwal and Anurag Pahari, says the report.

Unfortunately, there was no stopping to this practice even after formation of Apex Development Bank, which resorted to window dressing and covered its mistakes by doctoring figures on balance sheet rather than taking stern action against loan defaulters. This pushed up the share of non-performing loans of the bank to 27.2 percent of the total credit in mid-July 2016, as against 11.5 percent reported by the bank in its balance sheet. This caused capital adequacy ratio to slip into negative of 12.5 percent as against the regulatory requirement of 11 percent.

Apparently, the malpractices which had corroded the bank’s balance sheet were not detected when NRB conducted regular inspection of the bank in January, 2014. These defects were also not detected when the NRB conducted special inspection of the bank through support of KPMG, one of the big four auditors of the world.

The KPMG report, a copy of which has been obtained by the Post, did identify some of the risk factors at the bank, such as practice of revolving credit facilities, credit risk associated to credit portfolio and recoverability of real estate assets. The report prepared in December 2015 also says several credit exposures have not been provisioned properly. But it has not issued any warning signal.

What is also surprising is that due diligence audit (DDA) performed at the time of merger between Apex and NCC Bank and another DDA conducted at the time of merger between Royal Merchant, Rara Bikas Bank and Api Finance could not expose these malprctices.

“It is difficult to trace wrongdoings when cosmetics are applied,” said the NRB official. “Yet the central bank is cautious about theses incidents and will increase surveillance to detect these deceptive practices.”