The HR Khan committee on corporate bond market has proposed that banks should be allowed to pledge corporate bonds as collateral to borrow funds from the Reserve Bank’s overnight repo window.
As of now, banks can only pledge government securities to borrow from the Reserve Bank of India, and allowing them to pledge corporate bond could spur more buying of the debt by lenders. “To begin with, the RBI may consider accepting corporate bonds for overnight LAF (liquidity adjustment facility) operations as risks related to rating downgrade and change in market price of the underlying collateral would be minimal. Based on experience gained, it may be extended for long term repos,” it said.
The corporate bond issuance is dominated by private placements as these account for more than 95 per cent of the total issuance of corporate debt and a majority of the issuances are concentrated in the 2-5 year tenor. The proposal has been made by the high level panel — comprising representatives from the finance ministry, RBI, Securities and Exchange Board of India (Sebi), Insurance Regulatory and Development Authority of India (IRDAI) and Pension Fund Regulatory and Development Authority (PFRDA) — which has also suggested various other measures to deepen the country’s corporate bond market. The ‘Report of the Working Group on Development of Corporate Bond Market in India’ has been submitted to RBI Governor Raghuram Rajan in his capacity as chairman of the FSDC (Financial Stability and Development Council) sub-committee, which comprises of members from various regulators and had had set up the group.
The report was released on Thursday by Sebi, whose chairman U K Sinha is a member of the FSDC sub-committee. The group was constituted in September 2015 under chairmanship of the then RBI Deputy Governor H R Khan and has now submitted its report after taking into account various structural issues impinging on the development of a deep corporate bond market in India.
The report added it would impose some limits, including limiting the corporate bonds that can be pledged to top-rated securities.
It did not specify when the final approval would be given since it would require change in the RBI Act, while a clearing and settlement mechanism would also need to be developed. “Internationally, many central banks accept corporate bonds as collateral for their liquidity operation. It is not uncommon for central banks to take a lead with a view to developing the financial market,” said the report.
Sebi also proposed allowing insurance and provident fund companies to invest in hybrid capital debt instruments, including additional Tier I or perpetual bonds. Banks are the main issuers of those securities and would benefit from an expanded buyer base. The panel also proposed setting up a platform to guarantee and settle corporate bond trading, to make it similar to the one for government bonds.
The report said market participants need a debt market index as benchmark. Sebi is in dialogue with stock exchanges to design a suitable debt market index, it said.
“Large corporates with borrowings from the banking system above a cut-off level may be required to tap the market for a portion of their working capital and term loan needs. Necessary guidelines may be issued by the RBI taking into account market conditions by September 2016,” it said. The panel also wants necessary amendments in FEMA regulations to allow investment by FPIs in unlisted debt securities and pass through securities issued by securitisations.