Can WLTF banks fill the void?

Healthy condition of banks is very essential for a well-oiled economy and strong economic growth. The Indian banking system has recently come under the spotlight due to a significantly high percentage of non-performing assets (NPAs). The Reserve Bank of India (RBI) has been assiduously working along with the government and banks to resolve the NPA problem. Recently, the RBI also identified 12 insolvent accounts, which are responsible for 25 per cent of the NPAs in the Indian banking system. The move is laudable as it will help banks focus their energies on specific accounts to recover their money. One of the notable things about the insolvent accounts is that infrastructure and manufacturing sectors, such as power, telecom, transportation, aviation, metals and textile, contribute the maximum towards stressed assets. Projects undertaken by companies in these sectors are typically long gestation and linked to economic cycles. The very nature of projects makes it unsuitable for commercial banks to lend to these projects, as banks depend upon short-term deposits to fund them, which presents asset-liability mismatch (ALM) risk for the banking system.

India has a long history of specialised long-term financing institutions — from IDBI, IFCI and ICICI to newer financing vehicles like infrastructure debt funds and infrastructure finance companies. Some of these institutions morphed into retail banks while others vehicle could not take off as expected. Globally also, specialised development financial institutions take up the role of funding long-term projects. The RBI took a great first step in setting up such specialised institutions by granting licences to 11 payments banks in 2015 and 10 small finance banks, which would address niche areas in the banking system. In April 2017, the RBI released a discussion paper on setting up of wholesale and longterm finance (WLTF) banks to fund long-term infrastructure and corporate projects. This initiative could not have come at an opportune time. Due to the ongoing NPA issues, commercial banks are already wary to take further long-term exposures, thus creating a critical funding gap for these projects. Designing the WLTF banks The discussion paper by the RBI on WLTF banks lists out certain key design elements for these institutions. The RBI proposes an initial minimum capital of ~1,000 crore, which sounds reasonable given the nature of business. However, in the long term, the capital maintenance requirement should be linked to risk-weighted assets so that these banks are funded appropriately to the risk in their assets. One of the key skills in lending to long-gestation infrastructure and corporate loans is deep understanding of financial appraisal and cash flows of these projects. The RBI should ensure that the promoter group selected for WLTF banks has deep expertise in appraising long-term credits and tackling associated challenges. The RBI should also spell out eligibility criteria of projects that can be funded by WLTF banks such as sectors, nature of projects like greenfield versus brownfield and minimum tenor, etc. The RBI’s proposal of relaxing cash reserve ratio (CRR) and priority sector lending norms for these banks is welcome. However, relaxation in deposit insurance maintenance should also be considered. Regulations around NPAs and provisioning norms and recovery processes should also be adapted keeping bank’s purpose in mind.

Few critical areas deserve attention to make WLTF banks a success. Firstly, a key ingredient for WLTF banks would be its ability to raise cheaper long-term source of capital. The discussion paper proposes that these banks can raise current account and deposits above ~10 crore as one of the funding sources. This could prove to be counter-productive for the commercial banks. On the one hand, commercial banks would lose lucrative lending business to WLTF banks, and losing the current account and deposit business would only lead to financial hardship for the sector which is already being challenged by niche players like payment and small finance banks. In our zeal to create WLTF banks, we should not weaken the commercial banks and destabilise financial system. Instead, the best-suited source of capital for WLTF banks would be insurance companies, pension funds, sovereign wealth funds, international capital markets and long-term bond markets. To enable WLTF banks to raise funds from these markets, sovereign guarantee should be explored for enhancing credit worthiness. A suitable structure needs to be worked out for private participation such that proposed banks can avail the benefit of sovereign guarantee without overly depending on it.

Secondly, selecting the right promoter group for granting the licence holds the key. The universal banking licence criteria exclude large corporate houses. Assuming commercial banks are kept out of the promoter group, there would be very few players in the eligible promoter group which have the financial wherewithal and capability required for WLTF banks. Some of these institutions are already sponsors of infrastructure debt funds (IDFs) and infrastructure finance companies (IFCs), which have not performed according to our expectation. It would be crucial to understand how WLTF banks would be different from IDFs and IFCs.

Projects of infrastructure, commercial and industrial sectors have a significant impact on the gross domestic product growth and job creation in the economy. Setting up of specialised WLTF banks would surely give a fillip to the overall economic activity, However, it is important that this initiative is implemented in the right way, avoiding mistakes made by commercial banks in lending to aforesaid sectors. Detailed due diligence on the promoter group and framing suitable financial structures for raising long-term funds would go a long way in making WLTF banks a success.

The Reserve Bank of India should spell out eligibility criteria of projects that can be funded by WLTF banks