(read my views given below)
Mumbai, July 9:
Permitting banks to issue senior long-term bonds will help correct asset-liability mismatches (ALMs) and provide a tool to improve liquidity coverage ratio, according to India Ratings and Research (Ind-Ra).
Growing divergence in the tenors of loans and deposits has resulted in rising ALMs in government banks. For some banks, there is even a shortage of ready collateral that could be used to repo with the Reserve Bank of India in a liquidity squeeze, the credit rating agency.
Read What are root casues of Liquidity Problems
Read how uniform interest rate regime can solve many problems
Read how uniform interest rate regime can solve many problems
Senior bonds are rated at the same level as banks’ Long-Term Issuer Rating in the absence of a bank resolution regime and are not treated like loss-absorbing hybrid capital. Government banks have easy access to long-term investors such as insurance and pension funds and hence are well placed to tap this market.
Senior bonds issued globally by Indian banks have a good investor base. A similar (and possibly larger) market can be created among domestic investors.
“Indeed, investors take comfort from the benefits of government support, which is reflected in Ind-Ra’s stable Long-Term Issuer Rating of government banks during the economic slowdown in FY13 and FY14,” Ind-Ra said.
The existing guideline that permits banks to issue ‘infrastructure bonds’ has not found favour with investors, perhaps due to the implicit link with a sector that has been struggling to perform for some time.
The Indian banking system’s dependence on short-term liabilities has grown to a point where refinancing pressures are hurting margins. This also poses unique policy challenges, including diluted monetary transmission, a persistently flat-to-inverted yield curve and crowding out corporates from the commercial paper market.
Ind-Ra assessed that deposits maturing within one year increased to almost 50% of the total deposits in 2014, up from 33% in 2002. The ratio dipped in 2013 after growth in advances had moderated, before rising in 2014.
A significant part of these deposits had maturities within six months and, for some banks, included a growing share of wholesale money market borrowings. The share has grown independent of the interest rate cycle and will likely be explained, paradoxically, as a strategy by banks to preserve margins by remaining at the short end of liability tenor, the agency said.
It added that the domestic yield curve is likely to remain flat to inverted, unless issuance volumes shift to the long-end of the curve. Regulatory initiatives that help banks address this challenge and push long-term savings will benefit the economy in the long run.
Banking reforms likely to arrive in Modi govt's first Union budget-Hindustan Times
A growing asset-liability mismatch in the Indian banking system and the need to ensure a steady flow of long-term capital for the infrastructure sector have pushed officials to consider reforms to the use of senior bonds as a bank funding tool, the people said.
Details of the measures are still under negotiation ahead of the July 10 Union Budget statement, but the discussions ongoing within the finance ministry underline the new government's determination to address the failings of India's banking system.
India's mostly state-owned lenders have shied away from issuing senior bonds
in the local market simply because the Banking Regulation Act of 1949 does not
explicitly allow banks to do so. Some banks have circumvented the rules by
issuing senior debt overseas, but most lenders remain heavily reliant on
deposits and short-term funding.
Almost half of all bank funding in the country matures in one year or less, according to analysts, while nearly 80% of the Indian banking sector's funding is held in deposits.
At the same time, Indian banks are heavily exposed to the infrastructure sector, typically through long-term loans. As of April this year, Indian bank lending to the infrastructure sector stood at Rs. 8.4trn, up 11% year-on-year and nearly 15% of all Indian credit.
Such a mismatch in maturities raises the risk of a systemic crisis should short-term funding markets seize up, as proved to be the case in the US in 2008.
It also complicates efforts to raise long-term funding for sorely needed infrastructure projects, and leaves developers exposed to varying interest charges that can have a big impact on running costs.
"Banks keep annual resets on project and corporate loans so that they can align their short-term funding costs with long-term liabilities," said a DCM banker. "Banks generally avoid raising long-term money at market rates."
Big potential
Senior bonds are an established source of bank funding worldwide, and the potential for an Indian market is huge. Assuming restrictions are lifted, market participants believe Indian banks could issue at least Rs. 500bn-Rs600bn (US$8bn-$10bn) of senior bonds in the first year at tenors mainly of 10 to 30 years.
The government is expected to take a flexible approach to allowing senior bank bonds given the failure of a similar attempt in the past.
In June 2004, the Reserve Bank of India allowed banks to issue long-term bonds but attached a lot of conditions.
The RBI banned call and put options on these long-term bonds, and restricted the total amount of bond sales to no more than a bank's exposure to infrastructure loans with more than five years' residual maturity. Hardly any bank attempted such an issue.
The lack of senior bonds has also distorted risk pricing. "As Indian banks do not issue senior bonds onshore, their subordinated bonds get priced like senior bonds," said Atul Joshi, CEO of India Ratings and Research, the local arm of Fitch.
"In 2004 when the RBI allowed long-term bonds of a minimum five years to be issued, the pricing of those bonds also automatically got linked to the bank's subordinated bonds, plus investors started asking for a premium for the infrastructure risk."
Pricing skewed
Indian investors see little difference between senior and subordinated bonds, an approach that has been reflected in the rating of these instruments. But Basel-III rules, which require subordinated bonds to carry loss-absorbing features, are challenging that approach, and analysts believe a pricing differential between senior and subordinated bonds will eventually open up.
Senior bonds should come at least 5bp-10bp tighter than the subordinated Basel II-compliant outstanding bonds from the same bank, Joshi said. Other market participants said the spread between the senior and subordinated bank bonds might even go up to 50bp-100bp if a proper yield curve is established - as is the case in other, more developed markets elsewhere.
Privately owned lender ICICI Bank has made a few attempts to issue senior bonds onshore. In March 2013, the lender issued Rs11bn of 5.3-year senior bonds paying a coupon of 9.0%, 15bp-20bp tighter than its subordinated bonds at the time.
A flat-to-inverted rupee yield curve is likely to provide a further catalyst for long-term issues. At current benchmarks, an Indian company with a local Triple A rating can expect to raise 15-year money at a yield only 25bp higher than for one-year funding.
Modi's government has already approved a number of stalled infrastructure projects, and there is a strong case for banks to fix their asset-liability mismatches. The previous government set an ambitious infrastructure investment target of US$1trn in the five years ending 2017.
Nearly half of this investment was to come from the private sector, including banks - split roughly into US$150bn of equity capital and about US$350bn of debt.
Link Hindustan Times
My Opinion On Liquidity Issue
It is unfortunate that all policies framed by RBI and government of India in last two decades are directed to reduce savings and increase spending.
First and foremost is policy to reduce interest rate in banks during reformation era started from 1991 under the guidance of economist Mr. Manmohan Singh has made credit delivery from banks comfortable for corporate sector and small traders but reduction in interest rate on deposits has played more damaging role in last two decades.
Due to decline in interest rate on deposits made in banks, people are no more interested in keeping their idle money in banks but searching other avenues like gold or real estate to park their surplus income. This is why there has been continuous fall in growth of savings and due to which government has very little room to increase investment, neither in infrastructure nor in manufacturing sector or in social welfare schemes.
Due to fall in savings and resultant fall in growth in deposits received by banks, there is always liquidity crisis in banks. RBI and Government of India is forced to provide liquidity to banks by reducing CRR, SLR and by by lending at Repo rate or by other monetary measures. Besides banks is constrained to depend on sources of money like call money or bonds.
Due to liquidity problems, banks are not in a position to lend money to needy business men .Though banks are making best efforts to make more and more credit growth, their hands are tight. To add fuel to fire banks are not able to recover the money they lend as per schedule which further create mismatch in asset liability .Banks are not able to recycle money to create more and more money by sanctioning more and more loans.
Secondly government has policies more favourable for real estate builders, less for home seekers. GOI has given more concessions in tax in such a way that real estate builders get more and more opportunity to grow in wealth but adversely affects the purchasing capacity of home buyers. Cost of a house has gone up manifold during last decade than that in preceding five decades. Poor and middle class persons cannot afford buying a new house or a flat. Upper middle class may afford buying a house after taking loan from banks.
Due to continuous rise in prices of all commodities required for survival of life, common men without any rise in their income, 95 percent of Indian population is not in a position to taste the so called fruits of reformation era.
Further due to addition of more and more retail marts in urban areas, big towns and metros, public tendency to spend more and more has grown up without commensurating rise in their income. This is why saving capacity of middle class and rich class of India is also shrinking day by day. Further to add fuel to fire, GOI has allowed foreign companies to open their shops in Indian towns to give dangerous boost to spending habits of Indians as a whole.
Negligible portion of Indian population who can afford buying new and new electronic and other luxurious goods and services are also not bothered of making savings for rainy days. As in America, people of India are also now getting hassle free personal and consumer loans from banks which again cause erosion in savings growth.
It is important to point out here that banks are also promoting more and more retail loan because they consider these loans safer than other commercial loans. Due to this, capacity of businessmen to increase manufacture and increase their contribution in service sector has also decreased year after year.
In brief , until GOI changes it s policy and make them conducive for growth in savings and for growth in investment in manufacturing and agriculture sector , Indian cannot dream of solving its financial problems , it cannot dream of real welfare of common men , it cannot increase GDP growth on permanent basis , it cannot save sinking banks and what not.
Sooner or the later, GOI will have to frame uniform interest rate structure conducive for growth in savings and growth in capacity of banks to lend more and more in agriculture and manufacturing sector. Efforts of Government to distribute cash subsidy to poor may enrich their vote bank for a short period but in the long run this dirty policy will turn the poor as beggar and they will develop a habit of not working but depending on alms they will receive freely from politicians.
GOI may give free mid day meal to students but cannot force them to read until there is quality teaching in schools.
GOI may feel pride for MANREGA scheme but ground reality that rural mass are getting alms for few days but not in a position to work hard for earning real permanent income .
GOI may distribute subsidy in cash directly in bank but cannot inculcate good habits of work in rural and urban poor.
GOI will have to formulate and activate policies whic will help in creating more and more employment opportunities as their forefather created by SAIL, BHEL and other PSUs.
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