While all the authorities concerned agree on the paramount need for development of a healthy corporate bond market in India, some recent issues raise question marks about the actions or inactions of the two principal regulators involved — namely the Reserve Bank of India (RBI) and Sebi.
The RBI, in a circular issued on May 29, advised banks not to provide “guarantees or equivalent commitments for issuance of bonds or debt instruments of any kind”. However, banks can continue issuing “guarantees favouring other banks/FIs/other lending agencies for the loans extended by the latter”. To my mind, this creates a major anomaly. Since banks/FIs/ other lending agencies are professionals in the lending business, surely their need for another bank guaranteeing their loan is far less than that of the unsophisticated retail subscriber to corporate bonds? The anomaly is that the former is permitted, but the latter banned. To quote just one example, it is extremely unlikely that the recent Tata Motors bond issue would have been subscribed at the retail level but for the guarantee of the SBI. After the latest ruling, even companies with long-standing reputations like that of the Tatas may find it difficult to access the bond market.
Instead of banning guarantees for bonds, one would have preferred the regulator to look at the issue as an interim measure to promote a much wider development of the corporate bond market. There is a parallel to this in terms of the introduction/popularisation of money/capital market debt instruments, in the Commercial Paper (CP) segment. My memory is that initially, when the instrument was introduced, the issue had to be backed by a corresponding amount being blocked in the issuer’s working capital facility. This assured the availability of funding for repayment of the instrument, thereby promoting its acceptance and popularity. Once the market became used to buying and trading in CPs, there was no need for such back stop facilities. The same could well have happened in the corporate bond market as well. To my mind, there is a case for reconsideration of the ban on bank guarantees, at least as an interim measure: Else, the bond market may never take off. Such guarantees are probably even more necessary in the case of long-term bonds issued for financing infrastructure projects with long gestation periods. In the absence of guarantees, the retail investor would need to rely only on the rating company, which (s)he may not be fully comfortable with all that has happened in the global finance market. We should also not forget that, in the ultimate analysis, it is only the retail investor who can take the interest rate risk on long-term bonds, and there is a paramount need to attract him to the market. This apart, Sebi also needs to clarify the issue about secured/unsecured bonds raised by Somasekhar Sundaresan in an article (see Misleading regulations can kill unsecured debt market, June 1).
Regulators in the US and Europe are also looking at reducing the risk in off-balance sheet, over the counter derivatives. The aggregate notional principal of outstanding derivative contracts globally is of the order of $600 trillion with a mark-to-market exposure of around $34 trillion — obviously much lower than the notional, but still extremely large. Several proposals that are being considered include the following:
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All the right noises are being made, but one should keep one’s fingers crossed considering the lobbying power of the banking industry with the Congress, the administration and regulators to get the kind of regulations it is comfortable with. (A recent example, reported in the Wall Street Journal, is worth recalling. Banks successfully lobbied Congressmen to put pressure on the Financial Accounting Standards Board (FASB) to water down the rules for mark-to-market valuations.) There are just too many vested interests in the fat margins available in complex derivatives!
While on the subject, the RBI’s recent circular relating to capital norms for contracts settled through central counterparties is to be welcomed. This should facilitate and create incentives for banks to opt for guaranteed settlements of OTC derivatives like forex forwards and INR interest rate swaps through a central counterparty. Since margins are collected on a net basis through novated contracts, the capital charge should come down significantly.
Tailpiece: While our righteous indignation about the racial attacks on Indian students in Australia is understandable, is our behaviour with African students in Indian universities any better — even if we may not be beating them as regularly?