The Securities and Exchange Board of India (Sebi) is keen to mandate companies that have more than ₹ 100 crore as long-term borrowings compulsorily raise at least 25% of their funding needs by selling bonds. Sebi has joined the Reserve Bank of India (RBI) in nudging corporates towards the bond market through its latest draft paper.
The Indian corporate bonds market now resembles a high-end resort where one can enter by invitation only. It caters to only the best-in-class credit quality, has passive investors and ridiculously low trading volume.
It is not difficult to understand why regulators are pushing big corporates to access more of their borrowing requirements from the bond market.
First, large corporates are best placed to borrow through bonds. Second, bonds instil a stricter credit discipline as the company has to honour its payments from day one. A default tag can haunt for years with the borrower’s credit rating being downgraded. In contrast, loans are tagged as bad only after payments are three months overdue and are upgraded once dues are cleared.
The efficient risk pricing in bonds and the distribution of risk across different classes of investors is what makes the bond market a perfect antidote to the current bad loan problem in banks. The regulators hope that the banks will be able to sell their bond holdings to other investors, thus taking the risk off their books.
The ultimate objective is to give a measure of protection to banks in the event of these companies finding themselves in trouble.
The push towards the bond market will increase the volume of quality paper, reduce the concentration risk on bank balance sheets and instil much-needed credit discipline among borrowers.
But there are some misgivings, the most important being the philosophical one: Should a regulator tell a company what instrument is best suited for its borrowing needs? Surely the company is the best judge of that? If the bond market is all that attractive, companies would have flocked to it and there would be no need for Sebi to issue a diktat. For instance, when yields in the bond market were low, many non-banking financial companies accessed their funding needs from it, but with rising yields, they are going back to banks for loans. In this view, the proposed regulation is not so much a push as a rude shove. Bond market participants warn that the process would not be quick.
After all, the corporate bond market has been in slumber for decades and it would require some years for it to fully awaken. Ajay Manglunia, executive vice-president and head fixed income at Edelweiss Financial Services, believes that pushing corporate bonds is the best way to de-risk bank balance sheets. “What is required is creating demand through bringing in more investors in the market. The measures so far have been targeted at the issuers," he said. Over the last few years, RBI and Sebi have facilitated the creation of infrastructure to encourage borrowing through bonds.
The next step to push more issuers into the market is now being taken.
All it now requires is the right incentives to create a strong investor base.