The Reserve Bank of India (RBI) is considering issuing guidelines to banks to closely monitor end-use of funds available to central and state level enterprises. This is to ensure that funds are not diverted from commercial operations to provide direct or indirect support to state and central government budgets.
The central bank has also pointed out that a number of concerns relating to the private placement market still exist "and a regulatory review of bank's participation in private placement has become necessary in view of the systemic implications of private placements.
"State finances are under stress and hence recourse is being taken to extraordinary means of funding budget operations of non-commercial nature with bank finance," RBI deputy governor, Y V Reddy, said at a seminar organised by the Primary Dealers Association of India (PDAI) at Bangalore on Saturday.
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He pointed out that such funding was not only outside approved market borrowing programme, but was often outside formal guarantees. The diversion of funds raised by public enterprises ostensibly for commercially oriented purposes to support budget operations of the government concerned was a matter of concern.
"Such diversions lead to erosion of fiscal transparency, but more important, constitute diversion of bank funds raised through private placement for government's budgetary expenditures. In this process, the only backing for such assets is the guarantee of the central or state governments. These operations as they grow in size, distort both the fiscal and financial systems of the economy and give rise to potential for vulnerability," Reddy warned.
It is essential that the practice of routinely seeking guarantees particularly by central government owned institutions be given up and where seeking such guarantee is mandatory, laws be amended urgently, he averred and added that it will be necessary to ensure commercial viability of bank funding of operations irrespective of guarantees and automatic debit mechanism.
"It may be desirable to advice banks and institutions to dispense with the practice of seeking automatic debit mechanism. It is also essential for them to eschew any indirect support to the budgetary operations of governments through public enterprises," Reddy said.
Referring to the public sector units that issue bonds with guarantee of central/state governments that are outside the market borrowing programme for which approval from the RBI is not applicable, he pointed out that they carried higher rates than the coupon rates under market borrowings resulting in substantial distortion in market yields.
Around half of the non-SLR investments is invested in the private placement market. The quality of investments in such markets is uncertain as the market value of these investments is only half of the face value, he said.
Reddy added that a major concern is the liquidity of these instruments as most of them are not listed or even quoted in the OTC market and banks do not have an exit route. He said that information need to be obtained by banks/FIs regarding the exposure of companies raising funds through private placement as also the utilisation of funds and the bad loans on such investments.
On primary dealers Reddy said that PDs may consider increasing the size of their net owned funds besides enlarging the scope of stable short to medium borrowed funds. The holding capacity, market presence and intrinsic strength that a strong capital baser provides cannot be substituted by other sources of funding. Higher capital base and stable borrowed funding will reduce excess dependence on call money borrowings and RBI liquidity and the resultant risk on account of market volatility in uncertain circumstances.