Reserve Bank Of India Tightens The Noose Around Large Corporate Borrowers
Bank exposure to single entity to be restricted to 20 percent of Tier-1 capital starting April 2019
Large business houses like the Mahindras, the Tatas and the Birlas, may be forced to source their bank borrowings from a larger number of lenders starting 2019.
In an attempt to reduce risk across the banking sector, the Reserve Bank of India on Thursday issued final guidelines restricting the exposure that banks can have to a single entity and related parties. The guidelines follow draft norms issued by the central bank in August and will be applicable from April 2019.
Under the new norms, a bank cannot have an exposure of more than 20 percent of its Tier-1 capital to a single counterparty. Further, a bank’s exposure to a group of connected counterparties cannot be more than 25 percent of its Tier-1 capital.
As per existing rules, banks can have an exposure of 15 percent of its Tier 1 + Tier 2 capital base to a single borrower. In the case of a group, this limit is fixed at 40 percent. The lax rules had led to a build-up of risk across banks and the banking sector. In a series of ‘House of Debt’ reports, brokerage house Credit Suisse had detailed the build up of debt across 10 large business groups, some of which have struggled to repay bank dues. This, in turn, has led to a deterioration in bank asset quality.
To rectify this and to bring the Indian banking system in line with global standards, the RBI has imposed new exposure limits on banks.
The sum of all the exposure values of a bank to a single counterparty must not be higher than 20 percent of the bank’s available eligible capital base at all times. In exceptional cases, Board of banks may allow an additional 5 percent exposure of the bank’s available eligible capital base.RBI Notification
Defining Connected Counterparties
While prescribing a limit for group exposure, the RBI has also laid down rules to define connected counterparties.
The regulator has prescribed a list of benchmarks that will be used to determine whether different entities qualify as a ‘group’ and hence will be subject to the group exposure limits. Some of these include:
- Subsidiaries where an entity holds more than 50 percent
- Entities where the criteria of ‘control’ is satisfied
- Entities with relationships or dependencies such that, were one of the counterparties to fail, all of the counterparties would very likely fail
Exposure To Non Banking Finance Companies
The rules governing bank exposure to non banking finance companies (NBFCs) differ slightly from those governing corporate exposure.
“Banks’ exposures to a single NBFC will be restricted to 15 percent of their eligible capital base. However, based on the risk perception, more stringent exposure limits in respect of certain categories of NBFCs may be considered,” said the RBI while adding that bank exposure to a group of connected NBFCs will be limited to 25 percent of Tier-1 capital.
Saswata Guha, director at Fitch Ratings said that imposing limits as a percentage of capital and giving banks time to meet those limits is a reasonable way to address the issue of concentration risk in the banking sector.
The idea is to ensure that concentration risk comes down. To do that, introducing limits as a percentage of an eligible capital base is better than introducing hard limits. Somewhere the idea also is to push large borrowers towards other sources of funds like the bond markets which is healthy from a system perspective.Saswata Guha, Director, Fitch Ratings
Part Of A Larger Plan
Introducing limits on bank exposures is part of a bigger plan initiated under former governor Raghuram Rajan to change the way corporates in India borrow and shift risk away from the banking sector.
In August, along with proposing a limit of large exposures (which has been finalised on Thursday), the RBI had nudged ‘specified’ large borrowers to move towards financing via the bond markets.
Starting next fiscal, banks will have to set aside additional provisions to lend to borrowers which have loans of more than Rs 25,000 crore on their books. This will make bank borrowings more expensive for these borrowers and push them to consider raising money from the markets. The additional provisions would be applicable for borrowers with more than Rs 15,000 crore in outstanding loans starting fiscal 2019. Starting April 1, 2019, all borrowers with more than Rs 10,000 crore in loans would fall in the ‘specified borrower’ category.
While some concerns have been raised over the lack of depth in the bond market to support a rush of borrowings, the RBI has started the process of addressing that. A committee looking at deepening the corporate bond market, headed by former deputy governor HR Khan, had recommended that RBI could consider accepting top-rated corporate bonds as collateral at the central bank’s liquidity adjustment facility. This would give corporate bonds greater acceptability and lead to more liquidity in that market.