The RBI's decision to permit banks to sell 7-year bonds on which they don‘t have to keep reserves could well create a new and robust market for them.
Many finance ministers, Sebi chairmen and RBI governors have pondered over developing the corporate bond market but several factors like large fiscal deficit and predominance of the bank system of lending have stunted the bond market. Arun Jaitley, in his maiden Budget, delivered a blow and gave a lollipop to the bond market.
By taking away the lower tax advantage of debt mutual funds of less than three years, he has reduced their kitty by at least one and a half lakh crore. But what the government took away, the RBI may have returned.
The central bank's decision to permit banks to sell 7-year bonds on which they don’t have to keep reserves could well create a new and robust market for them.
But will it be able to create it? To know the answer CNBC-TV18 spoke to a panel of experts, which includes Shilpa Kumar, Senior General Manager at ICICI Bank, Neeraj Gambhir, MD & Head-Fixed Income - Nomura India and Jayesh Mehta, MD Country Treasurer at Bank of America Merrill Lynch.
Below is verbatim transcript of the discussion:
Q: Banks can now issue bonds without any encumbrances. They do not have to keep statutory liquidity ratio (SLR), cash reserve ratio (CRR) and do priority sector lending on them and therefore, it becomes a marketable bond. What is the total amount that can be issued in this category in FY15 itself? What is an approximate size of this market?
Kumar: At this point, we are just dealing with systemic data. If you look at systemic data across all banks, the number is fairly decent in terms of the outstanding exposure to infrastructure as well as to affordable housing. Both these elements come somewhere close to Rs 15 lakh crore and being allowed to issue bonds at about 16 percent of this number, assuming at this point that all of it is eligible, the number can be fairly large.
But it will be a function of a lot of things. It will be a function of the ability to get a good price to these bonds, how do they compare with other borrowings that banks are doing, how infrastructure projects themselves pick up and how fresh infrastructure growth is going to be. It is going to be a function of a lot of these things.
Q: The RBI has said that you can issue 7-year bonds, they will get a CRR, SLR priority sector exemption if they are used for infrastructure but you can issue bonds to the extent that the market is able to absorb, is that not capped?
Kumar: Yes. You can go ahead and issue these bonds but ultimately, it is the attractiveness of the pricing vis-à-vis other borrowings that the bank does and would determine how much issuance happens.
Q: What do you think will be the appetite? Pension funds insurance account for about one lakh crore maximum of longer-term bond appetite; will there be appetite for all the bonds that are issued?
Gambhir: No, at this point in time if you look at the real investor class that banks can chase, it is going to be insurance companies and provident funds. Those are the real long-term investors that this country has. There are some income funds that mutual funds had but that size is not much large.
Your estimate of one lakh crore seems quite reasonable to me. I don’t think even this one lakh crore has to be divided between the bank issuers and the non-bank issuers, the likes of HDFC, IRFC, PFC who are also issuing in the same category. So you have to think about as to what will split between bank and non-bank issuers. As far as pricing is concerned it will play a very important role.
I don’t think banks will be very interested in issuing these bonds if the pricing is where the current market is, for let’s say a PFC or REC which is say a 9.5 percent for a 10-year bond. I am not sure that banks will be very keen to issue a lot of paper at this pricing but if we see market pricing coming down to about 9 percent or lower than that there could be some interest. Again, both from supply and demand size it may not be as large as the stock of infrastructure lending that the banking system suggests.
Q: Do you think there will be appetite for all kinds of bank bonds? The top notch, ICICI, SBI are attracting enough appetite, do you think there will be appetite for United Bank bond, Dena Bank bonds especially now because we are on absolutely the crest of NPL problems?
Mehta: You are absolutely right, there won’t be appetite for all the bonds at the similar pricing. Banks tend to price it irrespective of the rating and capital adequacy and also tend to price it within quarter percent range. What we saw in one of the banks recently and its capital adequacy, there is going to be some distinction.
But overall we are looking at the current scenario, you have only provident fund and insurance companies but the big picture is yes, there is a huge appetite for the entire amount of bond and by all kind of issuers. But the biggest challenge and the biggest story where we are all missing out big picture is both for equity and debt the bank deposit rate has been a very big showstopper for Indian retail to get into financial market.
If you look at last few years, on an average bearing one year or so, you have government bond at 8 percent, corporate bond at 9 percent, deposits at 9.5 percent and that is the reason you don’t really see debt mutual funds also coming in. It is only high net worth individuals of some large corporate who get into fixed maturity plans (FMPs).
Q: But do you think the freedom that is now given to banks to issue bonds will reduce the interest in deposits at all? Is that game changing?
Mehta: If it does not change then nothing happens. Think this is just paper story, some smart bank might be able to issue and get away with but otherwise nothing really changes materially. Unless deposit rate comes down, I don’t really see how it will change the bond market or the financial market or any such thing.
Q: Do you think unless the yields come down a bit you will not issue bonds well over 9 percent or no bank will, what is your hunch? Is there a 7-year bond market or a medium-term bond market likely to emerge, if not this year then at least in the next two or three years when a substantial kitty will be available?
Kumar: More than absolute level what is important is at that at what level will bonds come relative to the other sources of borrowing. Relative to deposit market, relative to CD market, so in a sense that price target would be dynamic.
There are advantages to this bond issuing, depending on which bank and how it calculates the profitability of doing these bonds. There could be various degrees of savings that a bank could make. So you will certainly see some issuances at appropriate levels and that level is appropriate vis-à-vis the prevailing deposit rates and CD rates.
Q: Will it be 50 basis points above highest deposit?
Kumar: Let me not give you that kind of a number. Somewhere between 9-9.30 kind of levels, maybe at current levels people might attract but you used the word game changer. This year lots of game changing moves have happened. One, it is the whole liquidity coverage ratios that banks will have to adopt and what a borrowing like this can have an implication for banks’ calculation of LCR because it does given them an ALM benefit by issuing long-term. So, there are those kinds of issues which one needs to take into account.
Also, last year, you had a lot of tax free issuances which have moved out of the market at least for this year. To that extent, there would be some money flowing into the taxable space.
Q: There is a likelihood of decent amount of appetite for bank bonds, will it become active market, will it get traded? It is suppose to get listed and traded. As you get more and more headroom year after year for banks to issue these bonds, is there a chance of a hectic market developing in that space?
Gambhir: Over a medium-term this will be a very important move for the market. It will prove to be an important move for the market because we will have a proper bond curve that can develop on the back of bank bond issuances. Initially, they might issue 7-10 year bonds but as time passes these bonds will run down in their maturity and so, we will have shorter-term points coming up.
Historically, we have had this issue that apart from few financial institutions no corporate issuer of very high quality is been in the market issuing steadily, consistently sizeable amount of bonds. Therefore, to that extent, it fills a void in the market; it provides alternative set of issuers.
The demand side will also emerge slowly as the long-term investors will diversify their holdings away from the current concentration that they have on FIIs plus the FII interest in bank bonds is also something to be watched out for. Currently, there is a limitation on how much government bonds can they buy.
We have already hit the limits. Currently, the window that is open is on corporate bonds and everybody is comfortable with non-bank risk. So, bank risk is something that a lot of players are comfortable with. It is another area which we need to look out for and see how much demand comes in from there. Overall, in the medium-term it is a good and positive step, it will help development of a kind of a bond market curve, if you will across a set of issuers who are going to be steady state, large size issuers in the market.
Q: Do you think any more is needed in terms of liberalising this market, can these bonds be collateralised, at the moment there are no Put and Call options, even then do you think market could develop in three years down the line, hectic market, secondary market?
Mehta: I am not negative about it. It is a right step. Unless the deposit rates are substantially lower than these bond rates at least to the extent of 100 bps, you are not getting new investors to actually coming to buy.
FII is one part of it but then you are just competing in the space where, REC, NTPC and others were borrowing and therefore, it will not be able to come across all the banks and some smart banks, few banks would be able to take opportunity of it. But overall for the market to develop whether it is directly by individuals or through mutual funds unless the deposit rates becomes unattractive and that is the time you will see people looking at bonds. Till the time deposit rates are attractive rates, anything above 9 percent is an attractive rate in even absolute return term, people have been able to get that rate throughout and that is one of the reasons people in India are not getting into financial asset both debt and equity.
We are very proud of our equity market but if you look at individual retail participation – there is hardly anything. So that is the key picture I would look at it, the rest is all means and how we can get into it in a better way and taxation –FMP was one class where certain smart investors or HNIs or some corporate were getting into FMP.
Now we will move to three years FMP or they may go into growth scheme of mutual fund but in growth scheme people somehow do not like insecurities because they do not know what the yield is going to be – that is what people will have to get use to it.
Q: Will the corporate bond market be seriously maimed by the one-and-half lakh crore eventually going out? Will that money ultimately stay in the system and come back in some form in the bond market or is this a body blow by which the bond market may take a while to come out and you as a CD issuer would be affected by it as much?
Kumar: When there are structural changes like what happened in this Budget, the market does get impacted in the short-term but eventually it settles down and maybe sometimes it settles down in a different way. It could possibly even be in a better way.
A lot of that money actually goes into short-term paper and what you might actually see happen is eventually for things to stabilise, maybe a lot of that money stays with mutual funds or come back into bank deposit, but if it is staying with the mutual fund, you will see it move into slightly longer duration paper.
The market form will change. I don’t think it will dramatically affect the bond market. It will possibly move demand from the short-end towards a more medium to long end.
Q: Do you think appetite for CDs will not be affected by this? Will you continue to get the kind of yields that you are able to manage?
Kumar: CDs is part of the short-term paper that I was talking about and in a situation like this you would see times when liquidity is tight. It is possible that you will see substantial tightness in the CD market. But these are things that eventually markets absorb. Re-strategise around and find a way forward. There could be short-term implications but eventually the market should settle down.
Q: Do you think the bond markets will emerge after a bit of adjustment from this debt mutual funds losing or standing to lose a bit of their money because of the tax arbitrage going away? Will they ultimately be able to emerge from it and more importantly, how do you see the entire corporate bond market along the curve in three years?
Gambhir: It is a disruption but it is not a body blow. The market, like always, will readjust and will comeback. I see the issuance of bank bonds as a positive, a medium-term positive and I feel that once the bank bond curve emerges that helps people price some of the other credits a little better and as the new investors like FIIs come in, you will see better price formation and better liquidity in the medium-term but in the short-term you will have some disruptions in the shorter-end of the curve.
Mehta: I want to actually put a couple of things on record. On one side we are talking about REITs getting a pass through, SPVs getting a pass through status. Mutual fund which is a pass through status and I am really surprised nobody talks about the underlying instrument, the tax benefit still remains.
It is one year and 10 percent without indexation and 20 percent with indexation but if you go through mutual funds you are actually having a negative treatment. It is not a pass through treatment.
Having said that, if FMPs go, it will actually develop the market in a much better way. People will get use to getting into the mutual funds but for that a precondition is your deposit rates have to be unattractive. You might have some banks issuing couple of bonds, you might say Rs 50,000 crore issuance.
There will be FII who will break up, there will be existing guys who will break up. But if you really want the market to develop you want wholesale participation of retail and individuals and this will not come if your deposit rates remains attractive.
Q: Would your bet be that three years down the line we are going to stare at a much better corporate bond market?
Kumar: I think so, in fact when we look back from three years, we will see this year as a substantial change for the corporate bond market. My hope is that structurally supporting elements relating to capital, relating to liquidity coverage, if these elements kind of come in a good way, we can actually have a much better market three year hence.The Great Diwali Discount!
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