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Home / Opinion / Views /  Why rollout of secondary loan market is good news for all

With Axis Bank lining up 1,000 crore worth of loans for sale on the Secondary Loan Market Association’s platform later this month, India’s financial market takes one more step towards greater transparency and efficiency.

The market for bank loans is different from a market for corporate bonds or securitized assets. Loans are not, cannot be, as standardized as bonds, and have to be purchased in large chunks, as a proportion of the total loan in each case; nor is the platform on which the loans would be traded a securities market regulated by the markets regulator Sebi. The regulator is the Reserve Bank of India (RBI), the regulator of banks, above a self-regulatory body. The market participants would be banks on the seller’s side and banks of different sizes, non-banking finance companies, insurance, pension funds and mutual funds on the buyer’s side, apart from asset reconstruction companies, which already buy bank loans when they go bad.

A bank gives a loan to a borrower based on a relationship, and based on the bank’s own understanding of the viability of the project for which the loan is being raised. The loan could build in specific conditions binding on the lender or the borrower or both. For relatively small periods (tenor, in the jargon) and relatively small amounts, loans are just fine. When the loan amount is large and the tenor is long enough to create an asset-liability mismatch for the bank, it makes sense for the lending bank to sell the loan off to willing buyers and create liquidity. Retail loans, say housing mortgages, are routinely securitized and sold off, but corporate loans have typically been illiquid. This is about to change.

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There would be multiple benefits. Chief among them is external assessment of loan pricing. Too cosy a relationship between the lending bank and the borrower might lead to the cost of credit being unrealistically low, that is, the relevant risk factors might not be fully priced in. This might be for totally valid reasons, such as trust, born out of past experience of the borrower’s entrepreneurial success. Or it could be for reasons not so valid, such as non-commercial factors of persuasion behind sanctioning the loan. If the loan is sold on a secondary market, different sets of eyes would appraise the loan and an arm’s length pricing would emerge. Variance of this price with the price arrived at by the original lender would tell its own tale. This price would permit future loans to be priced better.

Pricing information gleaned from the working of the market for loans and the track record of repayment would permit realistic credit default swaps, which insure the credit against default on repayment, to emerge. This, in turn, would help crystallise a market for corporate bonds.

India is a fast-growing emerging market that needs to build much of the infrastructure that would be required to enable and sustain growth to achieve prosperity for its giant population. That would call for lots and lots of debt. Ideally, large infrastructure projects should be financed by long-term bonds, bought by the likes of insurance companies and pension funds that need long-term deployment of the funds entrusted to them. Bonds disperse the risk of default across society. In the absence of a functional market for corporate bonds, the risk of essential infrastructure projects would be concentrated in the hands of the banks that lend to these projects. A secondary market for loans helps, both by helping form the pre-requisites of a deep market for corporate bonds and by helping disperse the risk of a loan more widely than among the lending bank’s depositors, shareholders and providers of the bank’s loss-absorbing capital buffers.

A secondary market for corporate loans allows smaller banks and non-banking finance companies, besides asset managers who take on long-term liabilities such as insurance and pension, to take part in a juicy credit opportunity. The original lenders get a chance to dilute their exposure and credit risk.

The borrowers, whose credit is being sold down by the original lender, gain, too. Their lender base widens, making access to additional credit easier, to the point that they could even refinance their extant loans on better terms.

It has taken three years since an RBI task force recommended the creation of such a market for bank loans for it to start working. Better late than never.

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