New RBI norms to help de-risk balance sheet of banks: IDBI Bank

Last month the Reserve Bank of India (RBI) took two definitive steps to ensure that banks are not excessively exposed to over indebted groups. To begin with companies which have more than Rs 25,000 crore of total debt from all banks put together shall be identified and called 'specified companies'. 50 percent of incremental loans to these companies shall carry higher provisioning of 3.4 percent and additional risk weight of 75 percentage points. By 2019 the cut-off limit for such 'specified companies' will be brought down to Rs 10,000 crore. RBI has also announced draft rules for bank-wise exposure to companies whereby exposure of any bank to any company will be limited to 20 percent of its Tier I capital, down from 25 percent of Tier 1 and Tier 2 capital as of now. For corporate groups, similarly, exposure is limited to 25 percent of its tier I capital versus 40 percent of tier I and tier II capital permitted now. In an interview to CNBC-TV18, RK Bansal, Executive Director, IDBI Bank, says this is a positive move from the RBI and it is going to help de-risk the balance sheets of banks."The reality is the banking sector has suffered from large exposures in the past and as a result of that the Reserve Bank of India (RBI) is rightly looking at ways in which it can de-risk the whole banking system," says Ananth Narayan, Head-Financial Markets, Standard Chartered.But he adds that, if a capital and infrastructure starved country like ours is subjected to these regulations, capital and lending can become scarce. Below is the verbatim transcript of RK Bansal, Ananth Narayan, Ashish Gupta & R Govindan's interview to Latha Venkatesh on CNBC-TV18. Q: First up, Rs 25,000 crore is a fairly big limit for a single company. Do you think in FY17-18 itself a lot of companies are going to be impacted? Govindan: Starting Rs 25,000 crore may just be appropriate, may just be enough. However, as we go down to Rs 10,000 crore it will become challenging and let us say we have a metro company, their total project size may be around Rs 20,000 crore, Rs 5,000-6,000 crore of equity, Rs 14,000 of debt since bond market is not yet available for public-private partnership (PPP) projects or a metro project it is not yet ready, Rs 14,000-15,000 crore of bank debt, today most of the financing happens through bank debt. The other challenge you will also have is that if the bond market if it is not ready, even financial closure, for new projects I am saying, there is an old project and you will have some new projects as well. New projects, banks also will have to take a call on whether the new company which is the raising debt will have the ability to re-finance or ability to assume the debt from corporate bond market for that period, till then the financial closure cannot happen. I mean that is the sort of challenges you may have. Q: Your thoughts, is this a good step at de-risking or is it risking infrastructure? Bansal: I think both sides are true. If I really look at it, it is a good move to de-risk the balance sheet of the banks, but we need to understand two points, what we were just discussing, one thing which will perhaps happen with this move is that many of the project, which let us say companies putting with its own balance sheet, they will move towards special purpose vehicles (SPVs). Now that brings one more challenge for the banks that when you lend to the SPVs, we normally lend to let us say if a big company like Larsen and Toubro (L&T) takes money, certainly banks are more comfortable. When it becomes an SPV and now with Section 185 and all these issues, perhaps giving a guarantee also becomes a difficult thing. So banks may find it slightly difficult, but yes the exposure will move towards more SPVs that is one challenge. However, there the other norm which you mentioned in the beginning of 20-25 percent that will also come into play. So, that can to some extent risk the investment in infrastructure from the banking system. The other point which we need to see is, that in any case these groups who have so much debt today, perhaps they may not need so much money. All banks are telling them in fact to reduce the leverage, to reduce the debt, so additional incremental funding to these groups in any case may be somewhat less. _PAGEBREAK_Q: I just wanted to point out a matter of data which we worked out, the tier I capital of most banks is just about 2 percentage points lower than tier II. So, reducing the exposure to 20 percent from 25 percent of tier II or rather reducing the exposure to 20 percent of tier I from 25 percent of tier II may not really lower the limit a great deal. Also, with board approval, the exposure to a company can be raised up to 25 percent of tier I as well. So, should we really worry that the large exposure draft rules even if they became final rules will seriously reduce the limits of lending to infrastructure companies or any company? Narayan: I think we do need to worry, because we have to understand that as a growing economy, with a lot of requirement for infrastructure investments, the requirement for funding is only going to climb. So, if you are looking at a static situation of current capital and comparing that with the likely demand for investment funds let say three or four years from now, I think it is going to be inadequate. We also are starting with a situation where capital is scarce already as things stand. There is also the likelihood that more provisioning might eat up into capital even more. So, given all of that, there is a problem. I think it is a basic dilemma the reality is the banking sector has suffered from large exposures in the past and as a result of that the Reserve Bank of India (RBI) is rightly looking at ways in which it can de-risk the whole banking system. At the same time, for a capital and infrastructure starved country like ours, we have no choice but to ensure that flow of funds go into infrastructure for all the right reasons, whether it is for growth, whether it is for employment, productivity, inflation and so on and so forth. So, it is a dilemma that unfortunately we have to handle. It is a problem that we have to confront and yes I do think capital and therefore lending can be scarce, if we are subjected to entirely to these regulations. Q: I think the core point that the Reserve Bank is making is that yes the country needs infrastructure finance but that doesn’t mean banks should be pushed in to such a level of risk that about 40-50 percent of their exposure is to the top ten groups, now that was the finding of Credit Suisse. They were the people who first alerted us with a report from Ashish Gupta that banks are over-leveraged. So, basically is de-risking the banking system, is this correct? Gupta: I totally agree with the move that RBI has made and I think someone earlier talked about the fact that the groups that you mentioned or the steel companies you mentioned are not probably the candidates where anyway incremental debt allocation is being considered. However, I think this move of RBI really prevents a creation of another round of house of debt in the next cycle. What RBI has to be credited with is the timing of these guidelines because this is coming at a time when really for the first time we are seeing the corporate bond markets really becoming alive in India and also the fact that anyway large borrowers, credit worthy borrowers are more keen to move to the bond markets given the differential in rates they have for accessing funds from the bond market vis-à-vis banks. The additional impetus to the bond market is coming from the fact that we are finding that the current government is being very cognizant of its fiscal deficit and market borrowings. I personally believe one of the prime reasons why the corporate bond markets had not developed over the last few decades despite several committees trying to kick start it was the fact that the government borrowing program itself was so large-end, that pre-empted most of the funds. So, if we put these guidelines in the context of the environment they are coming in where large borrowers and credit worthy borrowers accessing funds from alternative sources is possible, I think RBI should be credited for looking to de-risk the sector at this point of time. To some of the points that have been raised about adequate credit not being available, I think these guidelines do not cap credit to anyone. What they only say is that credit flow should be only to entities which are credit worthy and the test it is putting for that is that if some entity can raise 50 percent of its credit from non-bank sources, say the bond markets and therefore it has a good credit standing banks are available to lend the balance 50 percent. So it is just putting a litmus test to whether the entity is credit worthy or not. Of course the person from L&T mentioned that several projects which are under construction and may not be credit worthy but there again RBI has a solution of banks being allowed to credit enhance a bond borrowing program. So, if you look at both the context and the various tools that RBI has made available, I think this is something that can work and frankly it is much needed. Capex needs are there for economies around the world but in fact India was an outlier in terms of prudential exposure limit, that 45-50 percent of bank capital could be lend to a single group. So, I think it is a much needed tightening and it is good that it is being done in the time when there is adequate liquidity available in alternate markets._PAGEBREAK_Q: What kind of suggestions to tweak these rules?Narayan: I agree with all of that Ashish mentioned just now. I would just caution that going through bond markets in the current state that they are in does not necessarily mean that we avoid the systemic risk that the system was subjected to earlier. It is not as if we can raise money for infrastructure through the bond markets in the current shape and form, all the issues of business cycles, governance, disclosures, execution will go away.I would argue that even if the previous business cycle had been funded by bonds, you would still have the same problem. I think a lot of the issues are common, the issues relating to bankruptcy law on which good progress has been made, the issues related to governance and disclosures, again on which good disclosures have been made, all these will help achieve some of those both for bond markets and for loan markets. No other country in the world have I seen, maybe I am missing out a few countries, have I seen direct directions which say that lending has to necessarily go partly through capital markets.There are of course single borrower limits which are defined in various places but no prescriptions which say you have to go through capital markets. Seeing capital markets as panacea, where everything is solved, given that we have lot of issues in the capital markets relating to investment limits, relating to disclosures, relating to bankruptcy, I would urge caution. We are going in the right direction but it is not a panacea.Latha: Any thoughts, any suggestions for the RBI on how this can be tweaked?Bansal: I have basically two points, first of all when the amount becomes Rs 10,000 crore it can hit even the very good groups also. So that’s one point. As other speakers also said, infrastructure funding as of now in the country has to be done by the banks, till we develop this bond market or something.So, I have basically three suggestions, one is the group exposure limit of 25 percent and that too of capital, becomes small for the groups because in the country today we have only a few groups which are involved in development of infrastructure. So, till we reach a stage where we have a number of groups I think that needs to be relooked at. Secondly for bond market to really develop I would suggest two things, one RBI has allowed that book value you can carry these bonds but that is only for the first year. Later on perhaps for some time RBI has to look at this, this mark-to-market provisioning needs to be relaxed for some time till we develop this market.Third is the investors in the bond market, if banks only have to subscribe to the bond then it is not going to work. So we need to relax the norms maybe to some extent by the mutual funds, by the insurance companies and by the PF trust. Today in fact most of these guys do not invest below AA and in infrastructure projects even with credit enhancement it will be very difficult to get AA or AA+ rating in many infrastructure projects.Q: 50 percent credit enhancement can take it?Bansal: Yes 50 percent credit enhancement but finally I am talking about who are the subscribers. 50 percent credit enhancement when only -- finally either banks will have to -- some other banks will have to subscribe because today if you really look at it, PF trusts are not subscribing to these bonds, mutual funds are not subscribing virtually, they are looking at AAA or AA+ type of rating. So, till the bond markets develop that is one issue I feel we need to see.The fourth point I would say is the penalty is too steep, 3 percent additional provision plus 75 percent additional risk weight, I think those also perhaps need to be looked at because in some cases we will have to, till the bond market develops you have to keep on lending at least to the good groups. I am not saying this house of debt or whatever is there and I am not even saying or advocating that we will lend to those groups but otherwise lending to even good groups will perhaps have an issue.Q: I just have two points, one I think in 2019, RBI itself mentions that they are open to that Rs 10,000 crore review, after all the value of that Rs 10,000 crore will not be what it is today. Separately with that risk weight 75 basis points and 3 percent provisioning the RBI calculation is that interest rates for those groups may go up by 1.5 percentage points so it is not really all hell breaking lose. What are your thoughts that good groups can still borrow?Govindan: I want to get a different perspective, I think the issue is not just infrastructure, if you look at development of India, many groups as RK Bansal said, they have provided the thrust for major industrial development, if you look at L&Ts and TATAs and all that. So, the group definition includes infrastructure companies, it includes the core company, many of the groups have got NBFCs, and many of the groups have got other businesses as well. So the group definition is much wider. This is one.Second is it includes not fund base limit, it also includes non-fund base limit. Bank exposure the way it is defined you have Rs 70 lakh crore of advances today as of March 2016, bank advances, you have got Rs 7,20,000 crore of tier I capital and if you add Rs 80,000 crore of foreign bank capital into India, Rs 8 lakh crore is what is available. The group limitation is around Rs 2 lakh crore so for large groups which have got financial services business which has let us say has got some Rs 70,000-80,000 crore of -- as of today, I am talking about as of today, Rs 2 lakh crore will be the group borrower limit. The banking system as what Ananth Narayan said is not going to add too much of tier I capital because of various provisioning since Rs 2 lakh overall limit can at best become Rs 2.30 lakh crore or whatever it is. So it will grow at a compounded at 4 percent per annum because of various issues.Now the group companies, since they are expanding at 25 percent or 20-25 percent per annum, the need for capital - if you look at some of the larger groups, whatever numbers I have done, they are already at Rs 1,50,000-1,60,000 crore of group limits. They may need around Rs 2,20,000 crors or Rs 2,30,000 crore or Rs 2,40,000 crore worth of group limit. So you almost have to work with all the banks.Other than this Rs 70 lakh crore of fund based limits, fund based limits can be managed through capital market, what is not possible to do is bank guarantees. If you look at large infrastructure companies 25 percent of turnover or 25 percent of total projects you have to give performance bonds. Performance bond if it is -- they carry a exposure norm of 50 percent and one of the suggestions which I can definitely give is that from a capital provisioning perspective that is linked to rating, so, 50 percent of that if it is AAA rated, they add 20 percent to that. So, basically only 10 percent of the total exposure they have to provide capital for that.So this is for the capital adequacy perspective that is the way they have defined. So even for the exposure definition if they can do that, this will be a big benefit to some of the companies who have sort of large conglomerate structure , who have businesses in various formats, who also continue to develop infrastructure; the problem is in the non-fund base limits.Q: Ashish, any suggestions?Gupta: I think what Ananth Narayan said is correct that Rs 25,000 crore going to Rs 10,000 crore, those limits are very prescriptive. I think over time what the regulator should move to, limits which are based on percentage exposures but I guess given the backdrop of where we have come from over the last four to five years, the regulator had to use a blunt instrument at this point of time. However, going forward I think more and more the reliance should be on the 20-25 percent single borrower or group exposure limits.