Raghuram Rajan’s last hurrah: Changing the way companies borrow
Mumbai: “This is my last policy statement, but there are still 28 days in my term which I intend to use fully,” outgoing Reserve Bank of India (RBI) governor Raghuram Rajan had said on 9 August while delivering his last monetary policy review.
He wasn’t kidding.
With just 10 days to go before he steps down, Rajan has unleashed changes that could have a significant impact on the way companies finance themselves.
For years, it has been said that the Indian economy is too bank-dependent. The reason cited for this was the lack of depth in the corporate bond market. But it was always a chicken-and-egg situation. Investors complained about the lack of quality credit. Issuers complained about the lack of investors.
Rajan is now attempting to resolve both those issues in one shot. In separate decisions announced on Thursday, the RBI said it will move to cap exposure of banks to large borrowers while also taking steps to deepen the corporate bond market.
Starting next fiscal year, banks will have to set aside higher provisions for incremental lending to borrowers who have a certain amount in outstanding loans from the banking sector.
The banking regulator suggests the creation of a new segment of borrowers called “specified borrower”.
A specified borrower is defined as anyone who has aggregate fund-based credit limits (ASCL) of Rs.25,000 crore in 2017-18, Rs.15,000 crore in 2018-19 and Rs.10,000 crore from 1 April 2019 onwards.
When this specified borrower comes back to banks to borrow more, half of any borrowing over and above the ASCL will attract additional provisions and higher risk weights.
Banks, however, can subscribe to bonds issued by these specified borrowers subject to a condition that these bonds will be divested over time.
The idea, very simply, is to force larger borrowers towards market borrowings and reduce the systemic risk created by the concentration of bank funds in a handful of corporate houses.
When a discussion paper on this was issued, a common complaint was that the corporate bond markets are not deep enough to support any substantial shift of borrowings and that lower-rated companies don’t find investors in the bond market.
Well, Rajan has the answer to that too.
In a separate announcement, the RBI said it will take a number of steps to deepen the corporate bond market. As a first step, the RBI says it will allow banks to provide greater credit enhancement to bond issues.
Credit enhancement is essentially a way to improve the credit rating of a bond issue. This is done by structuring the bond issue in such a way that the bank provides a source of assurance or guarantee to service the bond.
Until now, banks were allowed to provide partial credit enhancement to the extent of 20% of the bond issue. Now, the banking system overall can provide credit enhancement up to 50%, even though individual banks can only have exposure of up to 20%.
The decision should allow lower-rated borrowers to come to the bond market and permit regulated investors (like insurance companies) to invest in bonds issued by a wider range of companies.
To provide more heft to corporate bonds, the RBI also said it will eventually start accepting corporate bonds as collateral at its liquidity adjustment facility window. This essentially means that banks can use corporate bonds as security to borrow from the RBI.
This needs some changes in the RBI Act and the regulator says it has initiated the process to make these changes.
There are other nuts and bolts changes being made as well.
For instance, foreign investors will now be allowed to trade directly in corporate bonds rather than through a broker.
Another change is the decision to allow brokers to act as market markers for repo operations in corporate bonds, a move that will improve liquidity in the corporate repo market.
Will Rajan’s plan to make Indian corporates less dependent on bank funding work? This is another one of the outgoing governor’s gambles that will play out much after he leaves office.