The government has often voiced its desire to shift Indian borrowers to the capital markets from banks that are reeling from the burden of non-performing assets. Not only are capital markets better placed to price and absorb risk in varied sectors, but the inherent tradability of a debt instrument also makes it an attractive option for entities whose role in the capital markets is limited to temporary placement of treasury funds until they need to be used. This ensures greater availability of funds for borrowers.

The government, as well as the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI), have taken numerous incremental steps to stimulate interest in capital markets. Among these is the RBI's issuance of the Repurchase Transactions (Repo) (Reserve Bank) Directions, 2018, on 24 July.

A repo is defined as an instrument for borrowing funds by selling securities coupled with an agreement to repurchase such securities at a future date at an agreed price. Under the directions, a repo transaction can be entered into by entities regulated by a financial regulator (such as the RBI or SEBI), a listed body corporate, an unlisted entity that is using specified government securities as collateral, and certain specified government-owned financial institutions. Repo transactions can be entered into in relation to central and state government securities, non-convertible debentures that are listed, commercial paper and certificates of deposit.

Securitized debt instruments and security receipts are excluded from the basket of securities eligible for repos. While there is a case to be made for the exclusion of security receipts given that their value is volatile and depends on the recovery of the underlying debt, a similar case cannot be made for securitized debt instruments, which have a predetermined cash flow and are gradually entering the listed securities segment.

A repo can be undertaken for a minimum of one day and a maximum of one year. A repo transaction can be traded (with the prior approval of the RBI) on a recognized stock exchange, on an electronic trading platform authorized by the RBI, or in the over-the-counter market. A repo transaction can use a mutually agreed trading process. All repo transactions (other than those on stock exchanges and RBI-approved electronic platforms) need to be reported to the prescribed reporting platform within 15 minutes of the trade.

The directions prescribe the minimum "haircut" for eligible securities, i.e. the difference between the market value of the collateral and the amount lent against that collateral: 2% of the market value for listed corporate bonds, 1.5% of the market value for commercial paper and certificates of deposit, and 2% of the market value for securities issued by local government authorities. Additional haircut may be charged based on the tenure and the illiquidity of the security. The documentation for a repo transaction will be in the form prescribed by the Fixed Income Money Market and Derivatives Association of India.

The directions are welcome as they put in place a mechanism for market participants to use corporate savings to invest in corporate bonds. By enabling the infusion of cash in the financial markets, the directions create avenues other than banks for short-term borrowing by Indian borrowers. Further, by putting in place a mechanism to enable trading of bonds issued by Indian entities and short-term borrowings by other Indian borrowers, a tertiary market in corporate bonds is also being created thus deepening the overall market (and demand) for corporate bonds.

However, the issuance of the directions has been largely unnoticed and runs the risk of being consigned as a footnote in the history of the Indian financial sector. To ensure there is appropriate interest in this route, the RBI should consider making a move at par with SEBI's suggestion to require Indian borrowers to access the capital markets for 25% of their borrowing needs. One way to achieve this is by providing a temporary incentive for a defined period. For instance, the RBI could clarify that the holding of securities in respect of funds advanced by way of a repo transaction would not count towards sectoral or borrower-based concentration thresholds of banks and non-banking financial companies. In view of the growing interest for securitized debt instruments, these too could be included in the basket of securities eligible for repo transactions, a move which would further boost their popularity. If no specific fillip is provided, moves such issuing the directions only count towards good intentions and not much more.

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