This Will Change the Way Companies Borrow Money

Mon, 29 Aug Pre-Open

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The Indian economy is largely bank-dependent.

Reason...

Think of any corporate that wants to expand its capacity, invest in a greenfield project, or even wants to fund its working capital. What options does a borrower have?

Majority of them opt to borrow from the banking system. This is in contrast to the developed markets. There are other sources too. For instance bond markets form important source of borrowing. But speaking about India, this not the case. The market has failed to entice interest of investors and issuers both. Investors complain about the lack of quality credit. Issuers, on the other hand, complain about the lack of investors.

However, the outgoing Reserve Bank of India (RBI) governor Raghuram Rajan has unleashed changes that could have a significant impact on the way companies finance themselves. Last week, the RBI stated that it will cap exposure of banks to lend to large borrowers. Further it will also take steps to deepen the corporate bond market. This will serve two purposes.

First, the banks will have to set aside higher provisions for incremental lending to borrowers who have a certain amount of outstanding loans from the banking sector. Thus reducing the systemic risk created by the concentration of bank funds in a handful of corporate houses. And even help to reduce sector-specific concentration. Particularly the key sectors likes of infra, power and metal that have caused trouble for banks.

Second, in order to deepen corporate bond market, the RBI has stated that it will allow banks to provide greater credit enhancement on thr bond issues. Credit enhancement is essentially a way to improve the credit rating of a bond issue. This means the bank will provide assurance or guarantee to service the bond. So far, banks were allowed to provide partial credit enhancement to the extent of 20% of the bond issue. Now, the banking system overall can provide credit enhancement up to 50%, even though individual banks can have exposure of upto 20%.

With this, it will allow lower-rated borrowers to come to the bond market. Similarly, regulated investors (like insurance companies) will be able to invest in bonds issued by a wider range of companies.

Not to mention, the RBI has stated that it will eventually start accepting corporate bonds as collateral at its liquidity adjustment facility window. This means banks can use corporate bonds as security to borrow from the RBI. Since, this will require some changes in the RBI Act, the process is initiated to make required changes.

Similarly, foreign portfolio investors (FPIs) will get direct access to the bond market without having to go through brokers. Another change is the decision to allow brokers to act as market markers for repo operations in corporate bonds. This will help to improve liquidity in the corporate repo market.

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