Photo: Aniruddha Chowdhury/Mint
Photo: Aniruddha Chowdhury/Mint

Soon, large companies may have to pay more for borrowing

RBI proposes that banks make additional provisions, put aside extra capital when companies borrow more than a certain amount

Large companies like Tata Motors Ltd, Essar Steel India Ltd, Reliance Communications Ltd and even a highly rated entity like Bharti Airtel Ltd may have to pay more for borrowing, starting in the next financial year, if a new set of proposals by the Reserve Bank of India (RBI) take force.

RBI, which is trying to curb the banking sector’s exposure to large corporate entities, is proposing that banks make additional provisions and put aside extra capital when companies borrow more than a certain amount from banks.

RBI cited “high concentration of credit risk" in the banking sector while making these proposals in a discussion paper it put up on Thursday.

“While single and group exposure norms put a ceiling on the amount an entity can borrow from a single bank, there is no ceiling on total bank borrowing by a corporate entity. This has resulted in banks collectively having very large exposures to some of the large corporates in India, particularly in the power/ infrastructure, housing finance and steel sectors/ industries," RBI said.

“...many large corporates are excessively leveraged and banking sector’s aggregate exposure towards such companies is also excessively high. This poses a collective concentration risk to the banking sector, even when the single and group borrower exposures for each bank remain well within the prescribed exposure limits," the paper read.

To cut this risk, RBI wants to bring in a new set of rules by the financial year 2017-18.

The banking regulator suggests the creation of a new segment of borrowers called “specified borrower". A specified borrower is defined as anyone that has aggregate fund-based credit limits (ASCL) of 25,000 crore in the year 2017-18, 15,000 crore in 2018-19 and 10,000 crore from 1 April 2019 onward.

The implications of these proposals could be widespread, given that a number of companies have debt larger than 25,000 crore.

Tata Steel India had standalone debt of 25,332 crore as on 30 September. According to a statement released by Essar Steel in November, the outstanding debt of its holding company Essar Steel Holdings Ltd was 30,000 crore.

Telecom companies, which have been burdened with large borrowings owing to spectrum purchases, also had significant debt on their books.

As of 31 March, 2015, Bharti Airtel’s consolidated debt was $10.67 billion, according to company announcements.

India’s fourth-largest telecom operator Reliance Communications Ltd had reported net debt of 36,726 crore as on 31 March, 2015.

Credit Suisse’s i report, which highlighted debt-heavy groups in the country, listed 10 groups, all of which had debt close to or above the levels suggested by RBI.

These 10 group are Lanco Group, Jaypee Group, GMR Group, Videocon Group, GVK Group, Essar Group, Adani Group, Reliance Group, JSW Group and Vedanta Group.

The discussion paper says that half of any borrowing over and above the ASCL will attract additional provisions and higher risk weights. Essentially, this means that banks will set aside more capital to lend to these borrowers, which in turn may increase the cost of funds for the companies.

“RBI is essentially saying that large size borrowers should depend more on market borrowings rather than the banking sector," said Ashvin Parekh, managing partner, Ashvin Parekh Advisory Services.

“RBI wants to make sure that the bad blood in the system must be cleaned up. The creation of a specified borrower will help in reducing concentration risk; this means that the rate of borrowing would go up and force these corporates to go to the market. To deepen this market further, they are also allowing banks to participate in the bond issuances by these companies," said Parekh.

This is how the new system will work.

The fund based limits prescribed by RBI will come into effect starting the next fiscal year.

RBI proposes to create a normally permitted lending limit (NPLL), which is defined as 50% of the incremental funds raised by the borrower over and above the ASCL from the date it becomes a specified borrower.

“From 2017-18 onwards, incremental exposure of the banking system to a specified borrower beyond NPLL shall be deemed to carry higher risk," RBI said.

This incremental exposure will carry a 3% provision which will be distributed in proportion to each bank’s funded exposure to the specified borrower. The specification of “funded exposure" is important, since banks also have non-fund exposure to companies in the form of letters of credit.

The discussion paper also proposes “additional risk weight of 75% over and above the applicable risk weight for the exposure to the specified borrower".

This shall also be distributed in proportion to the individual bank’s funded exposure.

“This seems to be a reaction to the bad loan problem that banks are facing. The learning of this episode is that companies have borrowed excessively from the banking system as a whole, thereby increasing the risk in the system. The RBI is moving to limit that by asking banks to treat large exposures as higher risk exposures," said Vaibhav Agrawal, vice-president and head of research, Angel Broking Pvt. Ltd.

The central bank has stayed away from enforcing hard ceilings on borrowing for large companies, saying that this may hamper credit growth in an already subdued economic environment and adversely impact the business cycle. It would also be difficult for banks to prune their existing exposures to the companies at short notice, the regulator noted.

RBI also acknowledged that the corporate bond market in India is shallow and may not be able to support a sudden shift in borrowings.

To develop the bond markets, RBI says that banks can subscribe to bonds of these specified borrowers rather than lend to them directly. The bond investments won’t attract additional provisions but these bonds would then need to be sold down over a period of time till 2021.

“How is it that the banks are not allowed to lend beyond a certain limit, but they can buy bonds from these same companies? An exposure is an exposure," said Pratip Chaudhuri, former chairman, State Bank of India.

“At the time of recovery, banks will have to end up taking recourse to the same set of assets to get back their exposures, whether it is a bond or a loan. Moreover, there is no market for junk bonds in India. If the RBI feels that there is no risk in bonds, then they may need to consider providing repo (repurchase operations) for them," he added.