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Latest Revival for the Bond Market

Aug 18, 2018 | Emerging Trends Advisors

The report drafted by the Securities and Exchange Board of India (SEBI) on strengthening the bond market is practical and businesslike, and when fused in accordance with the RBI regulations for increased publicity, the face of corporate borrowing market will change from April 2019 onwards.

The ground for such a change in the bond market will only be exercised when companies accelerate their access of the bond market to meet their long-term requirements and concerns, and banks lending the finance instead of providing a term loan.

Such criterions have two reasons. Firstly, the asset-liability does not match because deposits are for a short-term whereas assets are for a long term. Secondly, these long-term assets are a very nasty part of the NPA story which requires to be addressed via the bond market as well as the Insolvency and Bankruptcy Code (IBC).

For companies who borrow more than 100 crores long-term borrowing for more than a year, with external commercial borrowings (ECBs) and inter-corporate borrowings excluded from the borrowing amount, a better exposure has been detailed.

The criterion of one-year tenurity has to be increased to three years, granted that the deposits made by the bank are also revised to three years. Also, for the same, a one-year classification is very outdated and bourgeois.

One should note that the reference to 100 crore means a 100 crore of the combined long-term borrowing made not only from the bank but borrowed from any place, like the RBI large exposure conditions. In such cases, the companies with AA ratings and above are forced to borrow at 25% addition required from the bond market.

Hence, a company will be granted 75 crores from other sources, and only 25 crores from the bond market. All this is done with the intention of boosting the bond market.

The reason for starting with the AA-rated companies is because of the assurance of SEBI that these big companies will not become defaulters as statistically revealed and that the defaulter rate of such companies is minimal.

Such conception is because of the saying that the debenture redemption reserve need not be created which is applicable for the non-financial companies and companies that choose the public issue for its need.

Corporate companies deal with two challenges. Firstly, if the company was term lending from a bank and also had to avail the use of debt markets, both the bank and the debt market adds up to the burden and thereby increases the expense. Secondly, and the most suitable is the cost of funding.

Track record shows that companies with corporate bond yields react easily with the interest rate environment.

As a result, when the RBI increases its rate of interest while lending money to the commercial bank in case of any monetary shortfalls, bank MCLR operates slowly whereas the bond yield responds quickly. As noticed, when the interest rates are down, the on-banking financial companies swap bonds from banks.

Likewise, companies have again moved back to the banks after the government securities have increased because of their credit policy. Hence, the funding cost increases when the interest rate rises and vice-versa. It is because of this nature of rate environment that the constant borrowers of this market are the most affected and the interest rate risk management, therefore, becomes a mandate.

Banks will be completely free as they can now work carefully and wisely in handling matters. But with the new rule of 25% being incorporated, the banks will now have to function more actively and put in more hard work in order to meet their own target since the concept of long-term helped them to go in for the big companies, which served their target.

In case of lending, the banks will have to be more choosy when AA-rated clients come into the scene since most of these clients move partly into the bond market, and in such situations, the banks will be left with more lower rated clients/portfolios.

Considering the entire situation, the initiative taken up by the government and the SEBI is overall good for the market, bringing in more order in the system and depending upon the IBC results, the same can be initiated to lower-rated investment-grade paper. This initiative will also make your approach more global, with the bonds market dominating and banks investing.

Even the credit default swap market and credit enhancement scheme will benefit out of the initiative which has been affected because of the existing state of affair. Companies with low ratings will look for ways to raise funds and CDS would more attractive which in turn will lead to its development.

Even today the credit enhancements have not done quite well. Yet, when the A-rated companies find the advantages in borrowing from this market, they will be forced to look for enhancements and work for higher ratings. This, in turn, will be not fund-based but the off-balance sheet.

In the last twenty years, the Indian financial system has had a positive evolution, including the transformation of development finance institutions (DFIs) into universal banks. It has been a common traditional belief that these banks worked in the same way as the DFIs did.

The banks attracted people with their CASA deposits (current account and savings account), assuming that these funds would remain static in proportion for a long-term and provided the asset liability management (ALM) congruence. This management provided better exposures to the infrastructure projects and various other heavy investment projects, which became a part of the non-performing assets (NPAs).

Recollecting all that has been said earlier, the question remains the same as to whether or not banks have the power to assess long-term projects when they are converted to banks? In this case, rather than making the debt market before the DFIs are converted to banks, preference is given to jumping the order. The initiative thus will surely have positive changes for the future borrowing and financial systems in making them stronger.

While the SEBI has conceptualized the initiative, more investors are required while the other operators need to build their foundation. A one-year term bond will do well for mutual funds, but definitely not for the insurance companies or provident funds.

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