MUMBAI : As the government plans to execute its $1.4 trillion infrastructure spending plan over the next five years, a secondary loan market that goes beyond banks to a wider range of participants, such as insurance, pension and mutual fund companies, can help in financing the mammoth capital requirements, experts said.
“If you are talking about $1.4-trillion infrastructure spends over the next five years, it has to be a combination of each and every other player in the Indian system, be it the asset management company or insurance firms or the pension funds, plus 40-50% of the money actually needs to come in from outside India," said Jayesh Mehta, India treasurer at Bank of America, during a panel discussion on “Developing Loan Markets". The panel also had Abizer Diwanji, head of financial services at EY India, Rajat Verma, head of commercial banking at HSBC India, K. Balasubramanian, head of corporate banking at Citi (South Asia), Nilang Desai, partner at AZB and Sanjay Singh, deputy chief executive at BNP Paribas India.
Infrastructure development is a key focus area for the Narendra Modi-led government. In September last year, a task force set up under the secretary of department of economic affairs drew up a report on the national infrastructure pipeline for the period 2020-2025. Its report projected a total infrastructure investment of about $1.4 trillion over the next five years. That is higher than the $1.1 trillion the government spent on infrastructure in the past decade, between 2008 and 2017.
But to achieve this ambitious target, the government needs to iron out multiple challenges impeding the development of a secondary loan market in India that would eventually enable banks to trade loans, transfer risk, create liquidity and re-optimize capital.
In September 2019, a task force set up by the Reserve Bank of India submitted its report on the development of a secondary market for corporate loans. It recommended setting up of a self-regulatory body (SRB) to oversee the proposed secondary market.
The SRB’s role, the report said, will be to standardize loan pricing, documentation and covenants, periodically review the documentation, ensure standardization of practices, and promote growth, liquidity, efficiency and transparency of the proposed secondary market. “Apart from banks, the other important players in the corporate bond markets are insurance funds, pension funds and mutual funds. It is said that 60% of all the incremental flow in capital markets is invested by these players in corporate debt," said BNP Paribas India’s Sanjay Singh.
However, standardizing loan pricing and documentation is an onerous task that would require multiple reforms in banking practices and regulations. “Today, to get new players into the market, the question is what type of documentation will they rely on. What type of pricing will they look at, what type of KYC (know-your-customer) you need to cover," said Citi’s K. Balasubramanian. “If you are looking at further broad-basing this market and bringing in new players into the market, I think a standardized approach makes a lot of sense. It needs some form of regulatory guidance, some form of regulators working together as well as legal counsel to bring in a standard set of documents," he added.
The added challenge, according to HSBC India’s Rajat Verma, is that different banks follow different strategies to price their loans, usually based on their own target customer segment, client relationships and liquidity position. But standardized loan pricing needs appropriate benchmark rates for secondary market purchase and sale of corporate loans.
“So, that’s the fundamental problem that you would tend to face in bilateral lending. You compound that with the fact that there is no market pricing benchmark, everybody’s MCLR (Marginal Cost of Funds based Lending Rate, the minimum rate below which a bank is not permitted to lend) is different and there’s no bank loan trading. Therefore, there’s really no price benchmark," he said.
“There is an element of lack of transparency in the pricing. I won’t go as far as to call it “lazy banking" but it is the lack of data that is the problem today. And that is not going to be solved without the real-time trading data. In lieu of that, banks will have to develop their own internal models to price risk and to price the security appropriately based on reasonably available information. Ultimately, it’s trading which will determine fair pricing," he added.
The SRB also suggested setting up an online loan platform to conduct auctions of secondary market loans. It said term loans have to be prioritized for the auction and, subsequently other categories of loans—revolving credit facilities (cash credit, credit card receivables), assets with bullet repayment and non-fund based facilities—could be introduced.
