For long, the balance of power between Indian corporates or businessmen and banks was skewed against lenders reflected in the inability of many Indian banks to recover their loans, and which saw their bad loans ballooning over the past few years. That prompted the government to introduce the Insolvency Law in 2015-16 which forced some of the biggest business groups to sell their assets or agree to a restructuring dictated more by banks or a shutdown, signalling a shift in the balance of power.
That balance will now further tilt in favour of Indian banks with the government announcing that capital market regulator Sebi is considering mandating large corporates — to start with — to raise about one-fourth of their financing needs from the bond market.
What this means is that some of India’s top business houses, which had traditionally been borrowing huge amounts from local banks, will increasingly need to go out to the bond market and raise funds from investors local and foreign.
It is rare that a regulator directs or mandates listed firms where to borrow from. In the West or developed markets, for decades, the bulk of the funding for building infrastructure — like developing roads, ports and airports is through the bond or the debt market. India had a stunted bond market but one which is now showing signs of life, with rising volumes and more firms tapping the market.
More and more companies are indeed bypassing banks to raise money through bonds at relatively cheaper rates thanks to yield-hungry foreign investors and domestic institutional investors. This could gather pace with the government having already directed some of the weaker banks to reduce their lending or exposure to corporate borrowers as part of the agreement to infuse funds.
Both these measures could, over the medium term, lead to the growth of a more vibrant corporate bond market and perhaps prompt banks to lend more to retail clients and small and medium firms to fill up the borrowing space which is bound to be vacated by the big firms.
The proposal to nudge big borrowers to go to the bond market was first mooted by the RBI. But the central bank then reckoned that it didn’t have powers to mandate borrowers where to borrow from. That challenge will now be Sebi’s. Earlier, the approach was to offer incentives to firms or issuers to borrow from the bond market. That hasn’t quite worked with many issuers or companies citing liquidity and the depth of the market as roadblocks.
While this fundamental shift may be welcome, what could be difficult is the transition.
For banks, lowering their exposure to corporate borrowers or less lending to that segment could mean a new category of borrowers — the next category after the big firms — with perhaps higher risks.
It would also mean harder work in terms of higher levels of due diligence than in the past and appraisal of projects. What will help is the move by the government which says that it will, along with regulators, take necessary action to allow bonds of a relatively lower rating to be eligible for investment.
That will work for firms which are perceived to be more risky and help develop a market for lower rated bonds. Whether risk-averse investors like pension funds or the EPFO will buy into this remains to be seen. Some of India’s top borrowers or companies were anyway borrowing from market segments — domestic or foreign whichever offered them the opportunity to lower their costs. But their day of reckoning will come when interest rates rise overseas and in India too and when they have a far more limited leeway to tap into bank funding.
What could also be interesting to watch out for is whether this influential set of borrowers lobby to apply the brakes on this move.