With ever increasing levels of non-performing assets (NPAs) in the banking system, the Reserve Bank of India (RBI) has been seeking ways to reduce the burden of providing credit on banks. In particular, the RBI has emphasized shifting long-term credit requirements such as project loans, and credit to borrowers with a large exposure to the banking system, to the bond market. Following its monetary policy announcement in April, the RBI released a discussion paper on facilitating "credit supply" for "large borrowers" through the bond market.
This discussion paper was a follow-up to one issued on the same subject in March 2015, and focused on discouraging banks from providing credit to borrowers exceeding a specific size so as to reduce credit concentration risk in the banking system. An ancillary goal of the discussion papers was to encourage borrowers to tap the bond market for their working capital and term loan requirements. Final guidelines, effective from 1 April 2017, were issued by the RBI on 25 August.
The guidelines define a "specified borrower" as one whose credit exposure to the banking system (including through privately placed debt instruments) exceeds `250 billion (US$3.74 billion) in financial year 2017-18, `150 billion in 2018-19, and `100 billion from 1 April 2019 onwards. Notably, the RBI's frequently asked questions section clarifies that external commercial borrowings and trade credits raised from overseas branches of Indian banks will count towards the aggregate credit exposure of an Indian borrower.
The guidelines define "normally permitted lending limit" (NPLL) as 50% of the funds raised by a specified borrower that are in excess of its credit exposure as on the date it became a specified borrower. This limit is enhanced to 60% if 15% or more of the specified borrower's credit exposure is in the form of "market instruments" (defined as bonds, debentures, redeemable preference shares, and any other non-credit liability other than equity).
Where the banking system's exposure to a specified borrower exceeds the borrower's NPLL, each of the specified borrower's banks have to maintain additional provisioning of 3% as well as additional risk weight of 75%, on a proportional basis, in respect of their fund-based exposure to the borrower. To ensure that the guidelines aren't circumvented by banks subscribing to market instruments issued by specified borrowers, the guidelines provide that such subscription by banks will count in determining a specified borrower's NPLL. The only exception to this is subscription to market instruments in financial year 2017-18 which are divested by banks as follows: not less than 30% by 31 March 2019, 60% by 31 March 2020, and 100% by 31 March 2021.
By making bank credit more expensive for specified borrowers, the RBI is, in effect, forcing large borrowers to raise credit through alternative means such as the bond market. In addition to the guidelines, the RBI is expected to take other measures to deepen the bond market and shift the credit burden away from banks.
In this regard, a persistent source of vexation for India's bond market is that inadequate credit rating prevents many from issuing bonds. This was partly addressed in 2015 by RBI directions allowing banks to provide partial credit enhancement up to 20% of a bond issue. This limit has been raised to 50% of the bond issue subject to a limit of 20% for individual banks, which is expected to increase the credit ratings of lesser rated issuers and special purpose vehicles, and make these "invest worthy" for bond market investors.
As a result of the above measures a number of specified borrowers are expected to tap the bond market within the next 12-18 months. Additional measures such as the introduction of a tripartite repo (to develop a term repo market in corporate bonds) are also expected.
The guidelines were much needed. While the RBI had prescribed limits on the exposure a bank could have to a borrower (and its corporate group), these limits were subject to the capitalization of individual banks (and therefore their growth appetite). This failed to reduce the concentration of credit with certain very large borrowers, resulting in systemic instability.
By limiting a borrower's exposure to the overall banking system, the RBI has compelled very large borrowers to turn to the capital markets for further credit growth, thereby setting the stage for a phased reduction in credit concentration. By compelling specified borrowers to reach out to the bond market, the RBI is also presumably addressing another weakness of the Indian financial markets – a weak bond market – as the rise in the number and the frequency of issuers accessing the bond market is expected to increase the depth of the bond market.
This article was first published in the October 2016 issue of the India Business Law Journal.
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