RBI measures need more heft to help corporate bonds

Steps such as granting more freedom to insurers and retirement funds to buy securities are needed, say investors

 The central bank’s latest measures to deepen the corporate bond market may not be enough and may require more steps including granting more freedom to insurers and retirement funds to buy the securities, investors say.

On Thursday, the Reserve Bank of India (RBI) announced a set of measures to encourage companies to borrow from the bond market, allowed lenders more freedom to give credit enhancements to lower-rated issuers, permitted foreign investors to trade directly in bonds and introduced a repurchase facility for corporate bonds. 

While these measures will have a positive effect on turnover and transparency in pricing for corporate bonds, more steps may need to be taken to deepen the market to the desired level, bond market participants said.

“There is no magic wand for the bond market and things cannot happen overnight. This is a start and many more steps are required,” said Ananth Narayan, regional head of financial markets for South Asia and Asean (Association of Southeast Asian Nations) at Standard Chartered Bank. 

For instance, RBI’s rule to make bank loans expensive for so-called specified borrowers will prod these companies to meet their funding requirements through corporate bonds. Specified borrowers are companies that have aggregate sanctioned credit limit of more than Rs.25,000 crore from banks in fiscal 2018. But to soak up this extra supply of bonds, the current set of investors may prove inadequate. 

What is required to create demand for this supply is allowing insurance companies and provident funds more leeway to buy bonds. 

“The rules of the other regulators (such as insurance, pension, provident fund) have not changed. What is required is the enhancement of buying power of the likes of Life Insurance Corp. of India and Employees Provident Fund Organization,” said a banker, requesting anonymity. 

Insurance firms, provident and pension funds are barred from buying bonds rated below AA. Also, the aggregate investment of these entities is also limited by respective regulations. 

RBI has, however, allowed banks more freedom in giving partial credit enhancements, a step that will help improve the rating of corporate papers of these companies and consequently improve their ability to access the bond market. Bond traders believe this is one of the most effective measures announced by RBI. 

Credit enhancement is essentially a way to improve the credit rating of a bond issue. This is done by structuring the bond sale in such a way that the bank provides a source of assurance or guarantee to service the bond. 

“The easing of partial credit enhancement for banks is a positive and will help low-rated companies to access the market easily. Of course, there is a price element to it,” said Sujata Guhathakurta, head of debt capital markets at Kotak Mahindra Bank. 

However, RBI still stipulates that a single bank cannot give credit enhancement of more than 20% of the issue size and enhancement of up to 50% of the issue size can be given by the entire banking system. 

Bond market participants have long complained about a narrow investor base, especially for low-rated bonds. With more freedom to give credit enhancements, banks will help such issuers get investment interest from long-term investors such as insurance companies and provident funds. 

In fiscal 2016, firms raised a record Rs.4.6 trillion by privately placing bonds, according to data from the Securities and Exchange Board of India. Fund raising by bonds has been rising every year since fiscal 2014. 

Another measure by RBI which aims to make it easier for banks to raise capital by issuing Tier-I and Tier-II bonds to overseas investors may not benefit banks that are in dire need of funds.

Moody’s Investors Service said in a note dated 26 August that although this opens up an alternate funding route for banks, overseas investors will be reluctant to buy Tier-I bonds given the lack of liquidity of these papers in the domestic market. 

“Banks’ capital requirements are large with the masala route providing an alternative. That said, these bonds are not an end in itself. Credit-challenged banks will find it difficult to raise funds through masala bonds,” said Amrish Baliga, head of structured origination at Deutsche Bank’s India unit. 

In a nutshell, the measures ease the fund-raising process for many companies and even banks, but not for all of them. The biggest measure is still awaited: RBI accepting corporate bonds as collateral in its liquidity operations. In its Thursday release, RBI said it was “actively considering” it.