The Reserve Bank of India has unleashed a wide array of reforms that can fundamentally alter the credit landscape in the economy. The comprehensive set of guidelines - possibly the last touch of Governor Raghuram Rajan - can address multiple issues: Reduce the disproportionate role that bank loans have in corporate funding, materially improve corporate bond market liquidity, and afford greater role for global investors. The rules are also expected to encourage innovation, and sharpen focus on risk-mitigation tools.
In a well-calibrated move, RBI's new rules attempt to achieve two broad objectives. One, dissuade banks from overexposure to any one corporate entity. For this, starting next financial year, banks will have to make higher provisions when lending to borrowers who have outstanding loans in excess of a certain threshold. For this purpose, the RBI has created a new category called "specified borrowers". Accordingly, any entity whose aggregate fund-based credit limits (ASCL) is Rs 25,000 crore (in 2017-18), Rs 15,000 crore (in 2018-19) and Rs 10,000 crore (April 1, 2019 onwards) will attract higher risk weights when seeking incremental lending. According to India Ratings & Research (Ind-Ra) estimates, the number of borrowers above the threshold of Rs 10,000 crore debt obligation is 50 - out of which potentially 24 are either stressed or fairly vulnerable. It is expected that the move will bring down the overwhelmingly large role of banks in corporate lending.
The second and related objective is to push companies, especially the bigger ones, towards sourcing their borrowing from the markets, instead of banks. Towards this end, the RBI has initiated a set of rules that will improve the flow of funds in the corporate bond market, which is at present rather small and shallow. Some of the measures will enable lower-rated borrowers to participate in the bond market. So, the RBI's announcements will undoubtedly have a positive impact on the development of the bond market while it lays down some red-lines for banks.
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Yet, increasing the size and enhancing liquidity in the corporate bond market would require addressing some structural challenges such as tweaking investment mandates of institutional investors (insurance companies, pension funds and provident funds), which do not permit large investments in corporate bonds, or improving functional trading systems so that it enables growth of a secondary market in corporate bonds.
Also, a proper bond market can only function on the basis of a robust credit rating system that tells potential investors the level of risk involved. But, there has been little independent assessment of India's rating agencies, although it was rating agencies that failed in the US financial crisis of 2008 because they were unable to assess the risk in complex derivative instruments. India has rating agencies of varying quality and some of them have issued sound ratings for organisations that quickly went bust. There has to be proper action to supervise and continuously assess their work so that unsuspecting retail investors do not suffer.
