The Reserve Bank of India (RBI) on 12 May 2016 released a discussion paper on a proposed ‘Framework for enhancing Credit Supply for Large Borrowers through the Market Mechanism’. The report says that the absence of an overarching ceiling on total bank borrowing by a corporate entity has resulted in banks collectively having very high exposures to some of the large corporates in India. The framework tries to mitigate risk posed by large borrowers to banks. However, there still is a missing gap and lingering concerns about these guidelines.
State Bank of India (SBI) in its Ecowrap report says, "A back of the envelope calculation suggests that the normally permitted lending limit (NPLL) of 50% will entail an annual inflow of Rs403 billion in the long term debt markets and Rs194 billion in the commercial paper (CP) market for FY2018."
The calculations have two important limitations. First, the RBI data is aggregate. Hence, the distribution of the companies is not accounted for. Second, the threshold for a ‘specified borrower’ is reducing over the next two years. This implies that the population under consideration is non-stationary. The combined effect of these is that the estimated flows are at a lower limit and actuals may be higher. This move by RBI may thus increase the size of the Indian corporate bond market by, say, only 1% of GDP from the current 17.8% of GDP and will not achieve the desired objective.
"We, thus, believe that this may not be the right way to develop the corporate market in India (there is no comparable rule in other countries restricting bank lending), which is at a nascent stage due to a number of issues and there may be a big funding gap for the infrastructure sector going forward," SBI added.
If one, now, looks at the framework for enhancing credit supply to large borrowers to mitigate the single-large borrower risk, the basic premise is to encourage such large borrowers to tap alternative funding. At present, there is no ceiling on total amount that a corporate entity can borrow from banks. Due to this, banks have high exposure to leveraged corporates in the country in sectors like infrastructure, power and steel.
According to the report, there are currently 57 rated entities whose total fund based rated limits aggregate Rs41.49 lakh crore. It says, "For the sake of curiosity, though not comparable, if we draw a parallel with total advances of all scheduled commercial banks (ASCBs) of Rs73.24 lakh crore (as on March 2016), these large borrowers account for 57% of total advances. Of the 57 entities, there are 22 entities that are unlisted. These entities are likely to continue to borrow into FY18 and beyond."
A standard asset provision of 3% is suggested on incremental exposures of banks in case it exceeds the NPLL. This will be distributed in proportion to each bank’s funded exposure. Banks can subscribe to bonds issued by specified borrowers above NPLL in the first year of framework coming into existence. However, banks will have to reduce its bonds exposure to specified borrowers during the course of next three years. Highly leveraged companies will look to tap money from the market, or may be forced to raise money overseas. If the leveraged corporates are offering bonds to banks, their ratings will take a hit.
But for a meaningful deepening of the corporate bond markets, SBI feels that numerous facilitators will be required to improve the appetite of domestic institutional investors. Under the proposed norms, banks will be penalised for taking any exposure beyond 50%of the incremental requirements of specified borrowers who have significant aggregate fund-based credit limits sanctioned by banks.
The Ecowrap report says, "In a similar vein, the total requirement of debt financing for infrastructure during the 12th Plan is estimated at Rs22.6 lakh crore. Our estimates show that after funding by private and public sector banks there is already an existing gap of around Rs11 lakh crore. The question is how are we going to fund the infrastructure sector? Alternatively, does the corporate bond market have the requisite appetite? These are unresolved questions as of now, even as we debate the draft guidelines".
"The objective of the draft guidelines by RBI is laudable, as there is help to the banking industry in terms of reducing concentration risk. Going forward, this will help the banks to reduce their NPA levels but the issue of increased capital requirement due to higher provision and risk weights would be a big concern for the banking industry as a whole," the report concluded.