The Reserve Bank of India (RBI) should allow credit enhancement on corporate bonds wherein banks guarantee such bonds to make the market more liquid and improve tradability, said S Vishvanathan, chief executive officer and managing director of SBI Capital Markets today.
“I know that recently there were some problems on banks guaranteeing corporate bonds. But if the regulator allows banks to guarantee the bond for the first two-three years, it can help particularly infrastructure companies to raise funds,” said Vishvanathan.
Credit enhancement is a mechanism, which helps improve credit rating of an instrument. It can be in the form of a guarantee, or collateralisation in form of security or cash.
ICICI Securities’ MD & CEO Madhavi Puri Buch agreed there was a need to allow separately price the issuer’s and the guarantor’s risk so that the pricing risk of credit enhancement by any state-owned entity was mitigated.
“So, there is a credit enhancement which happens separately so that underlying risk is priced as an underlying risk of whoever the issuer is, and the credit enhancement is valued and priced differently and if indeed it comes from a quasi-sovereign entity, then it should be priced accordingly,” Buch said.
The bankers were speaking at the banking seminar organised by the Indian Banks’ Association and Ficci. In May, the RBI had reminded banks to not guarantee bonds or debt instruments after State Bank of India guaranteed Tata Motors’ bond issue.
The central bank had said banks could only guarantee loans to corporates. However, the central bank had made an exception and allowed SBI to go ahead with the guarantee, but asked them to not enter into similar contracts later.
Tata Motors on May 20 raised Rs 4,200 crore through issue of SBI-guaranteed NCDs.
“The fundamental concern was ab initio, the instrument is carrying a credit risk of a public sector bank, which is a quasi-sovereign risk, but it is being priced as though it is a concrete private sector risk. This is distorting the market. This is a very valid concern,” Buch said.
“The question is to not have this side effect, but still be able to do credit enhancement. The answer is yes, provided it is not done ab initio.” Buch also suggested the need for separating the credit risk and interest rate risk through a bilateral contract to unbundle the pricing of a structured product.
“If a part of the risk is taken away, the investor appetite will improve, cost of capital will come down. If markets have to do that, we have to have a legal framework which in our system the contract Act permits. But it is not easy. There are numerous accounting implications. The legal framework exists but we are not permitted to enter into these contracts,” she said.
Bankers also debated on the need for keeping a restriction on capital market exposure of banks.
“The question is if 40 per cent of the net worth is a problem, then is it true that most banks are near the level. If that is not true, then what purpose will lifting or relaxing the cap serve,” said Prashant Saran, whole-time member of the Securities and Exchange Board of India.
Buch said the problem was the underlying assumption that capital market was a risky exposure.
“By putting a label, you cannot make it risky or non-risky. A personal finance loan against share with 50 per cent margin is a very safe product. Let us revalue the inherent risk, rather than by virtue of the label,” Buch said.
Saran agreed that more than quantity of restriction, using ethics while investing or formulating structured products was more important.
Meanwhile, Buch added that there was no plan on the anvil to list ICICI Securities.
