Financial intermediaries can bear risks for a longer duration than banks and generate higher returns
The Reserve Bank of India’s has released the report of the task force on the Development of Secondary Market for Corporate Loans. The broad idea is to give banks an option to sell their loans to other financial intermediaries and lighten their balance sheet. Why is this needed?
Traditionally, we know banks originate loans and then hold them on their balance sheet for maturity. However, in developed countries, alternatives have developed that allow banks to sell off their loans to other financial intermediaries such as mutual funds, hedge funds and the like and trade them as securities.
Banks need such alternatives when there are large NPAs (non-performing assets), some of which take time for the lenders to recoup. The other intermediaries need these assets as they can bear risks for a longer duration than banks and generate higher returns. This way, banks need not curtail lending and the economy continues to grow. This is how these secondary loan markets evolved in the US in the 1990s.
In India, these markets started in 1988, but are mainly inter-bank in nature, including financial institutions, where borrowal accounts are transferred from one entity to another. In 2006, the RBI streamlined regulations further and allowed sales of their assets as pools to investors (called securitisation) which had restrictions on minimum holding period and retention requirements. In 2016, additional guidelines allowed sale of distressed assets via auction.
The RBI guidelines also led to the creation of asset reconstruction companies (ARCs) which are specialists in this domain of stressed assets. The central bank currently has 24 registered ARCs which hold assets worth of Rs 3.79 lakh crore whereas the overall securitisation market has grown to Rs 1.92 lakh crore from the earlier Rs 71,000 crore.
The next step is to develop a vibrant secondary market in loans as activity has been lackadaisical. The task force has listed several benefits for the entire lending ecosystem.
It will help lenders optimise their capital, minimise asset-liability mismatches, conduct better risk management, and most importantly, handle stressed assets more effectively. For borrowers, especially those seeking large loans, it is a boon as they do not have to maintain relationship with the original lender. The government will be able to get a better output from capital infusion as it won’t be approaching banks sitting on stressed assets.
Also, development of corporate bond market is another positive, which in turn will help in overall development of India’s financial system.
The task force has identified quite a few bottlenecks in developing this secondary market for loan, quite similar to those seen in the corporate bond market: low participation, information asymmetry, stamp duty structure, documentation and so on. It proposes to get rid of these obstacles, apart from suggesting other measures.
Setting up of a self-regulatory body (SRB) of participants that will formulate guidelines and develop a virtual platform for transactions is a key recommendation. There has been a proposal to establish a Central Loan Contract Registry (CLCR) and push for standardisation of documents. The panel has also suggested allowing foreign portfolio investors and non-banking agencies such as MFs, insurers and the like to invest in the market.
It has also advised the government to encourage PSBs to sell these loans.
According to the task force, banks should first start with selling term loans and based on experiences, gradually sell loans like revolving credit facilities (cash credit, credit card receivables, etc.), loans with bullet repayment and so on. It has also talked about a transition path to minimise disruptions.
Once the SRB develops guidelines and the platform, the new loans should comply with the freshly minted standards so that they could be sold to secondary markets. The existing loans will be given an additional timeframe to comply.
To sum up, the task force’s suggestions lay the road to shift India’s financial system to a more market-based platform from the one that heavily relies on banks. It will also help develop the corporate bond market as both feed each other.
There are risks as well. Similar markets have created problems in the developed world where the inter-linkages of financial markets with each other have led to a much bigger crisis than it would have otherwise been.
But then, risks are part of life and have to be dealt with. Even in the 2008 financial crisis, the risks fructified mainly due to poor compliance and greed and not just because of these financial markets.
Moreover, Indian policy treads on all such measures very slowly and gradually. It is as if the Indian policymakers literally follow the famous line of Chinese reformer Deng Xiaoping, “Crossing the river by feeling the stones”.
It is likely to be the case with this new project of secondary loan market, too.Amol Agrawal is faculty at Ahmedabad University. Views expressed are personal.