Approach

Introduction: Explain the context of window dressing.

Body: Briefly explain the method and its effects on the banking industry and corporate.

Conclusion: Give a holistic conclusion involving corporate governance and forward-looking reforms

Answer:

The window dressing of loans refers to the practice of manipulating financial statements or records to present a misleading or distorted picture of the true financial health of a bank or a corporate entity. RBI Governor Shaktikanta Das raised red flags over banks adopting innovative methods for the evergreening of loans, covering up the real status of stressed loans of corporates to project an artificial clean image in cahoots with corporates.

Methods used by Banks and Corporates:

1. Bringing two lenders together to evergreen each other’s loans by sale and buyback of loans or debt instruments.
2. Good borrowers are being persuaded to enter into structured deals with a stressed borrower to conceal the stress.
3. Use of internal or office accounts to adjust borrower’s repayment obligations.
4. Renewal of loans or disbursement of new/additional loans to the stressed borrower or related entities closer to the repayment date of the earlier loans.

Affects the Banking Industry:

1. False impression of asset quality: Window dressing of loans can make a bank's loan portfolio appear healthier than it is. By hiding non-performing loans or inflating the value of assets, banks may give the impression of having lower levels of risk. This can mislead investors, depositors, and regulators, potentially eroding trust in the banking system.
2. Distorted risk assessment: When banks engage in window dressing, it becomes difficult to accurately assess the level of risk they are exposed to. This can lead to inadequate risk management practices and misallocation of capital, which can eventually undermine the stability of the banking industry.
3. Weakened credit quality: If banks resort to window dressing, they may extend loans to borrowers with weak creditworthiness or engage in risky lending practices. the banking industry. Eg - After the RBI Governor Raghuram Rajan ordered an asset quality review in 2014, a host of concealed bad loans or NPAs surfaced

Affects the Corporates:

1. Misleading investors and creditors: By manipulating financial statements, they can attract investors or obtain loans on more favorable terms. However, this misrepresentation can harm investors, creditors, and other stakeholders who rely on accurate financial information for decision-making.
2. Impaired transparency: undermines the transparency and integrity of corporate financial reporting. This hampers the ability of stakeholders to make informed decisions, distorts market efficiency, and creates an unfair playing field for businesses.
3. Increased systemic risk: If a significant number of corporates engage in window dressing, it can contribute to systemic risk in the economy. Financial institutions that rely on accurate information about corporates may be exposed to greater risk, potentially leading to financial contagion and instability in the broader economy.

Impact of window dressing on the economy:

1. Market inefficiencies: Misleading financial statements can distort market prices and misallocate resources. Investors may make decisions based on inaccurate information, leading to mispricing of assets and inefficient capital allocation.

1. Loss of confidence: Window dressing erodes trust in financial institutions, corporates, and the overall economic system. This loss of confidence can lead to reduced investment, decreased lending, and slower economic growth.

1. Systemic risks: Prolonged and widespread window dressing can contribute to the build-up of systemic risks, such as the accumulation of bad loans and fragile financial institutions. This can increase the likelihood of financial crises and have severe consequences for the economy as a whole.

To mitigate the adverse effects, regulators play a crucial role in enforcing transparency, disclosure standards, and effective oversight mechanisms. Strengthening corporate governance, implementing stringent accounting standards, and promoting ethical practices are essential to prevent and detect window dressing. The RBI must ensure that the banks are subject to strict oversight and governance reforms so that such instances do not have a significant bearing on the Indian economy at large.