Mumbai: Lenders may need an additional Rs 1 lakh crore in fresh capital over and above their Basel-III requirements if the Reserve Bank of India (RBI) goes ahead with its proposal to create a ceiling on bank borrowing by large corporates, according to a report by India Ratings.
“The banks may need up to Rs 1 trillion over and above their Basel-III capital requirements to manage the concentration risks arising out of their exposure to highly levered, large stressed corporates if the Reserve Bank goes ahead and implement its recent proposal,” India Ratings said in the research report.
Of the Rs 1 lakh crore of additional capital, the fund-starved public sector banks alone would need Rs 93,000 crore, India Ratings director and co-head for financial institutions Abhishek Bhattacharya said.
The amount is equivalent to an equity write-down of about 1.7 per cent of the banks’ risk weighted assets, and represents the loan haircut that banks may face to revive the financial viability of distressed accounts, the report said.
The agency estimates that about 20 per cent of bank credit will be to entities having aggregate fund based limits of Rs 10,000 crore and above now. These companies account for a whopping 40 per cent of the over Rs 8 trillion stressed accounts in the system now.
The new system seeks to limit single entity borrowing at Rs 25,000 crore, Rs 15,000 crore and Rs 10,000 crore for 2017-18, 2018-19 and 2019-20 onwards respectively and the agency estimates that if for any large company wants to grow entirely through bank funding, then the lending banks will have to set aside 150-200 bps provisions for those loans.
“If implemented effectively, this framework has the potential to address the significant concentration risks being posed by stressed corporates that currently account for 40 per cent of the banking system’s net worth over the medium term.”
“The median top 20 exposure to net worth for public sector banks was uncomfortably high at 220 per cent as of March 2015 and is estimated to have gone up further in March 2016,” says the report.
An RBI discussion paper released last week aims to improve the credit supply from the non-banking channels for large borrowers while also aiming to reduce concentration risks for banks, which shot up in FY16. But for a meaningful deepening of the corporate bond markets, multiple enablers will be needed so as to improve the appetite of domestic institutional investors.
Under the proposed norms, banks will be penalised for taking any exposure beyond 50 per cent of the incremental requirements of specified borrowers who have significant aggregate fund-based credit limits sanctioned by banks.
Mr Bhattacharya said the new system has the potential to gradually de-stress the banking system’s exposure to large leveraged corporates and provide the much-needed impetus to the corporate bond market development. But this can potentially impact growth in the medium-term, unless backed up by easing of the demand side constraints in the transition phase.
He also said the move can address the concentration risks for banks and provide a fillip to corporate bond market provided the demand side constraints are effectively addressed.
For the plan to be effective the regulator should address the constraints of the bond market investors, Mr Bhattacharya said, adding that the main reason for this is the fact that both the insurance as well as pension funds regulators discourage investment in corporate bonds which are rated below the ‘AA’ category.
“This shuts the door on the needy lower rated corporates and under the proposed framework can put additional pressure on their ability to diversify their funding mix. The recent norms to change mutual fund investment patters mandated by the Sebi (Securities and Exchange Board of India) to address concentration risk for mutual funds, could also impede the development of an efficient market, since it imposes ceilings on sectoral and group exposure limits,” Mr Bhattacharya said.
The agency believes that the Bankruptcy Code will take some time before it starts to offer any tailwind to the corporate bond market.
While the balance sheet driven stress will take a while before it starts recovering, it would take a demonstrated cycle of insolvency resolution under the new laws to instill investor confidence in the lower rated paper.
Noting that the bond market is already facing pressure from the recently issued UDAY bonds, he warns that a quantum jump in the corporate bond issuances in an environment of limited investor appetite may potentially create pressure on the overall bond yield curves.
The agency believes that the full implementation of Basel-III mandates will address the single name concentration issue to a large extent. Though the current framework takes a more systemic approach to address the concentration risk, the proposed framework aims at rationing appetite of banks while taking incremental exposure to large corporates.