Vault Matters: Proposed project finance norms - a push towards bond markets for India Inc

For one, provisioning norms for such loans, that is loans which could turn bad, sealed at 5 percent is a number that is unheard of for financial institutions.

Second, is a manner in which the circular may be enforced, that is having prospective and retrospective implications on loan exposures, which could add an element of uncertainty in project loans. The intention clearly seems to be to merge bad loan provisions for chunky corporate exposure with expected credit loss model, which is expected to see a rollout next fiscal.

The unintended consequences of the circular could possibly be to push the demand of chunky project exposure away from banking channels to surrogate banking products, mainly bond.

In other words, from pushing demand for direct credit to credit substitutes. This is also the third exercise by the regulator in attempting to do so.

Now, why could this happen?

Provisioning-related norms play a major role in viability determination of a project. This is also a dynamic concept and can affect a project loan at any point in time. On the other hand bond markets work on relatively stable covenants. It is about getting the rating right, pricing the issue right and finally ensuring that it covers the duration of project (whether 10 or 15 or 20 years) adequately.

Of course, how should a default in bonds be handled by financial institutions is still an unsettled matter despite being first-hand witness to 2018’s IL&FS debacle. Yet, the implication of default through credit substitutes causes a far lower pain on a financial services’ entity’s balance sheet as against a direct loan exposure.

The reason for limited access to the bond market is the challenge of getting the right rating to ensure a desirable price. As an effort to possibly ease this, National Bank for Financing Infrastructure and Development (NaBFID) a few days back said that it is open to taking exposures to India Inc through the bonds route and is also working out ways to facilitate credit enhancement. The latter in particular could play a significant role in strengthening the ratings of issuers hitting the bond market.

The first attempt to push India Inc in towards the bond market happened in 2017 when the RBI said that in cases where the banking exposure of a borrower exceeds Rs 10,000 crores, banks will need to take an additional provisioning as a measure of caution. This circular of the RBI took some time to roll out, but the large bonds from Adani to Tata to JSW group, suggests that after over half a decade, the circular is doing what it was intended to.

In other words, the first ever serious push by the regulator to redirect loan demand from financial institutions to the corporate bond market is yielding the desired results especially for large business houses. What would be interesting to see is whether the combination of NaBFID and the project finance circular, as and when it rolls out, will further propel this process. Of course, this is a narrative which will play out over the next 5 to 10 years. But if large ticket loan exposures have taken off well without hurting the banking system, especially in terms of asset quality issues, that would be a job very well done by the regulator. Let’s wait for time to tell.