Wholesale banks: Analysts want RBI to learn from past mistakes
The Reserve Bank of India’s proposal to introduce wholesale and long-term finance (WLTF) banks can be a reality if the central bank and the government show flexibility on how these entities would manage their resources.
If the earlier mode continues, where funds are raised at a fixed rate, to finance projects at a flexible rate, it would be nothing but a continuation of the old development finance institution (DFI) model that died a natural death, say experts.
The Indian financial system has for long had a clear demarcation between banks and long-term finance providers. While DFIs would give project loans, banks were providers of working capital loans. DFIs would raise money from the market through bonds, guaranteed by the government. These bonds had Statutory Liquidity Ratio (SLR) status -banks could buy and mortgage these with RBI to borrow money, something they do with government securities.
DFIs also would raise money from banks at a cheaper rate. Since the scope of lending was neatly divided between banks and them, there was no competition; both entities worked in a mutually exclusive field. Change The demarcation started getting blurred in the 1990s. In 1992, the government stopped giving guarantees for bonds issued by DFIs. In the mid-90s, RBI under C Rangarajan introduced a concept of ‘universal banking’, of any type of lending under one roof. DFIs found themselves in trouble as the source of funds became costlier and competition intensified.
Some of them — Industrial Credit and Investment Corporation of India and Industrial Development Bank of India (IDBI) — converted themselves into universal banks. Infrastructure Development Finance Co (IDFC) was the latest such entity to become a universal bank, in 2015.
Industrial Investment Bank of India shut shop. There are still DFIs continuing with the earlier mandate, such as India Infrastructure Finance Company (IIFC), Industrial Finance Corp of India and privately owned Infrastructure Leasing & Financial Services. However, not in their former glory. “The fundamental problem for DFIs was that their assets used to get repriced periodically, whereas the liabilities they raised remained fixed. The margin squeeze was a killer,” said Rajiv Lall, IDFC Bank’s managing director. “The model can work if there is a change in design. The resources to be raised can be at floating rates and there should greater flexibility in the maturity profile of the bonds.” Now RBI's discussion paper has not Wholesale and long-term finance (WLTF) banks will fund the infrastructure sector and corporate businesses
Objective
To raise funds through bonds, current accounts and minimum term loan of ~10 crore
Condition
WLTF banks will be required to maintain CRR, not SLR clarified on the maturity profile of the bonds but says these might not have SLR status. This, say experts, drastically brings down the bonds' attraction, even as SLR yields have recently veered near the actual cost of funds for banks.
In this environment, getting a new set of DFIs for India looks challenging, say experts. “The bond markets are relatively better developed now than 25-30 years ago but investors remain choosy about the ratings of issuers,” a rating agency executive said. Investors in these markets are averse from buying any bond that is rated below 'AA'. Therefore, it is important that WLTF banks have at least this rating.
“Therefore, if such a bank is floated by the government, it can have a good chance of succeeding in the space, as banks don’t have the necessary
Eligibility
Licence would be on-tap and eligible promoters would be same as commercial banks
Current rule
Industrial houses and corporate groups are not allowed to float full commercial banks expertise to evaluate long-term project finance and need to be protected from serious assetliability mismatches,” he said.
According to R K Bansal, executive director of IDBI Bank, new-age DFIs can function freely once an enabling environment, such as a recovery mechanism, gets robust. “There is no immediate solution but we are getting there through the NCLT (National Company Law Tribunal), Insolvency and Bankruptcy Code, etc,” he said.
S B Nayar, chairman and managing director of IIFC, said WLTF-type institutions are needed urgently. For, infrastructure financing is complex and specialised institutions should be part of the financial system. “Although the previous structure might not be relevant in the present economic scenario, the concept of dedicated, specialised, institutions focusing on developmental activities remains valid,” he says.
According to Nayar, the country's required annual investment in infrastructure is ~ 11-13 lakh crore. The average in the recent past has been ~56 lakh crore. Existing sources lack the capacity to finance this huge need.
Banks’ credit dues from the infra sector are about 10 per cent, whereas the sector’s share in bad debt is a little more than 15 per cent.
Nevertheless, the infra sector needs low-cost funding. This can come only when the WLTF banks themselves get to raise low-cost resources. Therefore, the government should help by making the bonds tax-free, said Nayar.
However, the entry barrier for these banks has been proposed at a very high level, at a minimum capital of ~1,000 crore, considering the projects they would undertake are capital-intensive. And, corporate groups are excluded from floating these. This restricts the participation of many potential promoters.
However, there are corporate-focused non-bank finance companies that can step in, said the rating agency executive. “Apart from such NBFCs, the government can float these banks. Beside, banks can come together as a group of investors to float such entities. There will only be a limited number of these institutions but they can do the job effectively,” he feels.