On the eve of stepping down from the gubernatorial post of the Reserve Bank of India, Dr. Raghuram Rajan underlined the need for some important changes in the financial market in India. An important one was to reduce the bank-dependence of the investors. As of now, the investors, particularly, the corporate investors are depending heavily on bank finance. How can this situation be changed? A way out is to finance itself by issuing bonds. But the main problem of issuing bonds in India is the low depth of bond markets. Actually, there has been a vicious circle of bond market. Lack of depth of bond market leads to lack of issuance of bonds. Again lack of suitable bonds in the Indian market leads to lack of good investors in bonds. The main purpose of Rajan seems to be breaking the vicious circle of bond market.
What Rajan said?
From the next fiscal, PSU banks will restrict disbursement of loan to a single investor of amount over `25,000 crore in 2018 and above `10,000 in 2020. If a bank has to disbar more loan to a particular company over and above the amount then the bank has to set aside higher provision extra lending. The noticeable thing in this case is that for the extra loan over and above the statutory level, the provision is to be higher in spite of no slippage of assets. This is because whenever the loan amount reaches higher levels the risk of repayment may be more. Then the rate of interest will be higher for the companies willing for getting bigger amount of loan. In this situation, it is expected the companies will calculate which one is better to pay the higher rate of interest or issuing
Rajan is also in favour of interest rate futures. One can also expect money market futures contract and a swap market in the days to come. There are miles to go to establish a vibrant corporate bond market in India.
It is true that raising the capital of private companies through issuing bonds has been rising. But it is still at its infancy.The H.R. Khan Committee report says that in percentage terms, it is very impressive. But the total corporate bond issuance has increased by around 236% from `1,74,781 crore in 2008-09 to `4,13,879 crore in 2014-15. Similarly, the number of issuances has increased by almost 153% from 1,042 in 2008-09 to 2,636 issuances in 2014- 15. But the secondary market trading continues to be very limited at around `2000 crore per day. For common investors, the low depth of bond market is a problem. No small investor can enter the bond market in India. The secondary market does not work well. An investor can not sell a bond easily if she/he needs money before the date of maturity. Only personal connection among sellers and purchasers of bonds is the way to transfer bond ownership.
Why a vibrant market in India is not developing?
The H.R. Khan Committee has given a report on the reason behind the limitation of the corporate bond market in India. The readers should know some of the issues and recommendations of the report. First, the corporate bond is dominated by the private corporate bonds. On the basis of FY 2014-15, about 95% of the total issued bonds are of private corporate bonds. Secondly, a majority of the issuances are concentrated in the 2-5 year tenor. Third, the investor base is limited/narrow as the investment mandates of institutional investors such as insurance companies, pension funds and provident funds, despite review of the minimum credit rating from time to time, provide limited space for going down the credit curve as the investments are made in fiduciary capacity to protect the interests of subscribers. Fourthly, small outstanding stock of individual issuances is one of the key factors impacting secondary market trading as reissuances have not picked up in spite of the enabling provisions by SEBI. Fifthly, there is total lack of liquidity in credit risk protection instruments like Credit Default Swaps. Sixthly, stamp duties on corporate bonds across various states have not been standardized.
Seventhly, there are inherent structural incentives for borrowers to prefer bank financing. Eighthly, as the corporate debt market cannot be looked as totally detached from the sovereign bond market, this market may get a fillip as the interest rates come down with the inflation and fiscal consolidation targets being achieved. Lastly, in the current context, many large non-financial corporates who should normally be the preferred issuers of bonds are leveraged and hence cannot access either loan from banks or bond financing through market mechanism.
Another big change in loan exposure limit of banks in the offing
There are three types of lenders to borrowers or companies in broad sense. These are banks, financial institutions, and non-banking financial institutions. For banks what is the maximum loan exposure limit? According to the RBI rule, a bank can disburse loan to a project, other than infrastructure, of a company a maximum of 15% of the bank’s net worth (capital plus reserve funds). It is 20% for infrastructure projects.Here capital means both of Tier 1 capital, that is, mainly the total equity of the bank and Tier 2 capital, which consists, mainly of money raising through bond selling. But the RBI is trying to change the definition of capital or net worth in disbursing loans. The plan is Tier 2 capital would not be considered as part of net worth. Only Tier 1 capital would come under the new definition of net worth for disbursing loan. The natural consequence will be the exposure limit of the banks will be lower and the borrowers can get lower amount of loan from the banks. This has been done with a view to luring the banks for other options for loans. One of the best consequences of the corporates would be to issue bonds. But as has been already mentioned that, if a corporate needs more money over and above the exposure limit, it has to pay higher interest rate for the extra money.Then corporates have to decide which way is better for them. It is expected that this will pave the way for better bond market in India.
A reliable bond market makes for a vibrant bond market. P. Srinivas, recently retired MD and CEO, United Bank of India, told BE that unless the high quality of bonds of the reputed companies are not ensured, the investors will not be interested in purchasing bonds. Here, the regulator, the RBI has greater role to intervene in the rating process of the financial instruments to make the ratings better. This takes time. But let the process for a better bond market continue.
This may lead to the desired result and the possibility of stressed assets may be lowered. But there are so many loopholes to make the banks sufferer. Political intervention and crony capitalism in India, like many other countries, is a chronic disease. One can hope and work for the best.