RBI Implements Khan Committee for Strong Corporate Bond Market


he idea of having a vibrant corporate bond market is well accepted in India. It would provide an alternative platform for raising debt finance and reduce dependence on the banking system. But it never really took off, largely because of policy and regulatory impediments. A number of committees such as the R.H. Patil committee (2005), Percy Mistry committee (2007) and Raghuram Rajan committee (2009) studied various aspects of the issue and made recommendations, but the progress has not been as desired.

Consequently, the responsibility of providing debt capital has largely rested with the banking sector. This has resulted in several adverse outcomes such as accumulation of non-performing assets, lack of discipline among large borrowers and inability of the banking sector to provide credit to small enterprises. But all this could change, as the odds are now beginning to shift in favour of developing a strong corporate bond market. And here is the evidence.

Last year, the Financial Stability and Development Council sub-committee constituted a working group under the then Reserve Bank of India (RBI) deputy governor H.R. Khan with representation from the government and other regulators. Its brief was to review the recommendations of the previous committees and suggest ways for implementation, as well as make further recommendations. The committee submitted its report in August 2016.

The RBI, drawing mainly on the recommendations of the HR Khan committee, suggests three distinct sets of measures. One, in order to improve the appetite for corporate bonds, banks and primary dealers will soon be allowed to offer corporate bonds as collateral in place of government securities (g-secs) in the Liquidity Adjustment Facility (LAF) window. While only top-rated issuers may benefit from this move, and that too with suitable haircuts on valuation, this change can be path-breaking in enhancing both appetite and liquidity for corporate bonds. Opening up corporate bond repos to registered brokers engaged in market-making may aid price discovery. Allowing banks to extend more guarantees on lower-rated bonds (credit enhancement) can shore up this neglected segment of the market. Two, in an effort to improve access for Foreign Portfolio Investors (FPIs) they are to be granted direct access both to corporate bonds and the negotiated dealing platform for government securities. Such dis-intermediation can reduce costs and boost yields for FPIs, but their overall demand will still be curbed by the statutory cap on their participation. Three, the proposal to curb banks’ exposure to large accounts through explicit borrowing limits (by FY19), is likely to force large borrowers to actively explore primary bond issues. This shift will increase the supply of good quality bonds and curb concentration risks for banks. Overall, while these ideas will undoubtedly boost the bond markets, they may also hit the business of banks. Direct corporate participation in the money markets may reduce the need for treasuries to maintain high current account balances. Large companies migrating to market borrowings may force banks to explore small-ticket lending. In the short run, this could well add to pressure on revenues and profitability for banks. But in the long run, active competition from the bond markets will force banks to ensure quicker transmission of policy rates.

However, these measures may not be enough to address structural issues such as the lack of a market for lower-rated bonds, or an illiquid secondary market. Here, nudging domestic institutions such as insurance firms, provident funds and banks to move away from their risk-averse strategies is critical. These institutional investors should be encouraged to build better in-house capabilities on credit assessment. But then, this is not the RBI’s remit. The Centre and other financial market regulators too need to take up the cause of bond market development.

Corporate Bonds

Corporate bonds are debt securities issued by private and public corporations. Companies issue corporate bonds to raise money for a number of purposes, such as setting up a new plant, buying equipment, or investing in organic growth of the business. When investors buy a corporate bond, they effectively lend money to the issuer, or the company that issued the bond. In exchange, the company promises to return the principal amount on a specified maturity date. Until that date, the company usually pays a stated rate of interest, generally semi-annually.

Tuesday, 27th Jun 2017, 11:34:40 AM

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