RBI says large firms have to pay more for bank loans, starting FY18

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Mumbai: The Reserve Bank of India (RBI) has proposed a major overhaul in the way large companies borrow. In separate decisions announced on Thursday, the central bank made it costlier for large companies to borrow more than a certain amount from banks even as it took steps to increase liquidity and participation in the corporate bond market. It also proposes to reduce the cap on bank exposure to large corporate entities.

Starting next financial year, large Indian companies will have to pay more for borrowing from banks—part of an effort by the central bank to curb lenders’ exposure to stressed corporate entities. Large companies accounted for 58% of total bank credit of Rs.65.47 trillion at the end of March.

According to guidelines that RBI released on Thursday, banks will have to set aside higher provisions and assign higher risk weights for loans (essentially set aside higher capital) to large companies beyond a certain limit.

Here’s how the guideline, which closely follows a discussion paper released in May, will work.

RBI intends to create a special class of large borrowers called “specified borrowers”. A specified borrower is defined as one that has aggregate fund-based credit limits (ASCL)—or total fund-based exposure of the banking system—of Rs.25,000 crore at the end of this financial year. This limit will progressively reduce to Rs.15,000 crore in 2018-19 and Rs.10,000 crore from the start of fiscal 2020.

RBI proposes to create a normally permitted lending limit (NPLL), which is defined as 50% of the incremental funds raised by the borrower over and above the ASCL from the date it becomes a specified borrower.

For loans over the NPLL, banks will need to set aside an additional 3% provision. They will also have to assign additional risk weights as high as 75%. This additional risk weight will also be distributed in proportion to the individual bank’s funded exposure.

Essentially, this means that banks will set aside more capital to lend to these borrowers, which in turn may increase the cost of funds for the companies.

The implications of these proposals could be widespread, given that a number of companies have debt larger than Rs.25,000 crore. Firms such as Bharti Airtel Ltd, which had debt of Rs.95,043 crore at the end of March, Reliance Communications Ltd (Rs.33,886 crore), Tata Steel Ltd (Rs.83,804 crore) and JSW Steel Ltd (Rs.35,171 crore) might end up being classified as specified borrowers and may have to pay a premium for further bank funding.

It wasn’t immediately clear how much of the outstanding debt of these large companies was funded by banks.

“This is mainly to check excess leverage or borrowings by corporates. We don’t see this impacting banks or corporates in the short-to-medium term as the investment cycle is weak. In the absence of a strong bond market, these corporates will have no choice but to borrow from the banking system. Thus, the impact of credit growth will be limited,” said Parag Jariwala, vice-president, institutional research, Religare Capital Markets.

The central bank said that banks may choose to subscribe to bonds issued by the large corporate entities after the NPLL is reached. They will, however, be required to redeem these bonds within three years.

As per the guidelines, banks will have to divest at least 30% by 31 March 2019, 60% within the year after and 100% by 31 March 2021. The central bank has said that it will review these guidelines in financial year 2019-20.

To further de-risk the banking sector from corporate loan exposures, the regulator is also considering capping a bank’s total exposure (including loans, on and off balance sheet items and market instrument investments) to a single corporate entity at 20% of its Tier-I capital, and for a group of connected companies at 25%.

This is a significant shift from present limits of 15% of capital funds for individual corporate borrowers and 40% of capital funds for a borrower group.

A connected borrower group will be defined on the basis of criteria defining control as well as economic dependence. Control is defined as a situation where one company is able to directly or indirectly control the other, while economic dependence will be established if one company can have a significant negative impact on the financials of the other in the event of financial stress.

Once the draft guidelines on large exposure framework become final guidelines, banks will have till 31 March 2019 to fully implement them.

In case of a single non-banking financial company (NBFC), bank exposure will be restricted to 15% of Tier-I capital, said the regulator. However, based on the risk perception, more stringent exposure limits in respect of certain categories of NBFCs may be considered, it added.

Exposures of banks to a group of connected NBFCs or groups of connected counterparties having NBFCs in the group will be restricted to 25% of their Tier-I Capital.

These norms will not be applicable for loans to central and state governments, state-owned firms and companies which have government guarantees.

“When you combine all the steps taken by the regulator today, it should help the bond market to move away from banks as the major funding entities and bring about a deeper and more vibrant market. It should also improve disclosures on a systemic level, since bond markets typically require far more clarity than other markets” said Karthik Srinivasan, senior vice-president and co-head of financial sector ratings, Icra Ltd.