The Hindu Business Line : Bank finance for mid-size corporates

Commercial banks, of late, have been focusing their attention increasingly on medium-sized corporate enterprises (MCEs) as a major avenue for credit deployment. The MCEs are much larger than micro, small and medium enterprises (MSMEs) but well below the size of large corporate houses and MNCs.

The mid-corporate universe encompasses a wide range of enterprises engaged in manufacturing, services and infrastructure sectors, with turnover ranging between Rs 50 crore and Rs 1,000 crore.

The MCE segment fetches banks higher net interest and ancillary income than the highly competitive large corporate accounts and, with the unit cost of carriage of the MCE loan portfolio being much lower than that of retail accounts, banks are attracted to the former.

In larger banks, such as the SBI, the mid corporate segment is categorised as a specialised business vertical. The quantum of bank credit deployed in the mid corporate segment is substantial, at about Rs 4,00,000 crore, of the aggregate loans and advances of scheduled commercial banks (SCBs) of Rs 24,00,000 crore at present.

Project Financing

A significant part of the banks’ lendings in the MCE segment comprises loans for setting up new projects. Banks usually stipulate a gearing ratio of 1:2 for equity to project debt, for eligibility of a project term loan. Of the total equity, the core promoters of the project are expected to bring in 26-51 per cent, and the balance is raised from private equity investments or through a public issue.

Thus, while the equity risk, comprising one-third of the project cost, gets distributed among the promoters and other investors, the risk on debt capital, funding two-thirds of the cost of the project, is borne entirely by the lending bank, rendering its stake in the project much higher than that of the promoters and other investors.

In developed economies, project financing is usually carried out through syndication of the debt and market placement of equity. In India, in the absence of a developed corporate debt market with attendant liquidity, projects are financed by banks and institutions through term loans and carried on their books till repayment.

In view of the higher financial risks borne by them, banks usually insist on ‘suitable and adequate’ collateral securities from promoters. However, such collateral, especially of immovable properties, entails realisation delays and risks. Moreover, the collateral security cannot be enforced independent of the event of default, as a hedge in order to bring down the outstanding loan, if the project is not faring well and the risk perception has deteriorated.

Equity Participation

Given the present system, and in the backdrop of past incidence of non-performing and stressed assets, aggressive acceleration of project credit in the mid-corporate segment, sans an effective means of control, could eventually cause serious repercussions for the banks.

It is imperative that suitable risk mitigation avenues are explored towards strengthening the lending banks’ position, on the one hand, and encouraging the growth and progress of MCEs, on the other. One of the best means of achieving the twin objectives would be to allow lending banks to partake in the management of the borrower company by participating in the latter’s equity.

The financing bank having appraised the project, and itself participating in equity, will infuse confidence in intending equity investors and facilitate expeditious financial closure of the project. Holding an equity stake, the bank would be able to better leverage its presence on the board.

The concept of equity participation is not new. Financial institutions (FIs) in India normally provide some equity support to projects financed by them as a developmental objective. Banks well entrenched and experienced in project financing deserve to be similarly enabled.

The proportion of bank’s investment in the equity could be mutually agreed upon with the promoters. The banks need not, and are not expected to, acquire a controlling stake and it would suffice if the bank’s holding is minimal, demonstrative of its participatory interest.

The exposure on equity investment and debt together can be contained within the quantum eligible otherwise for project debt. Suitable exit routes can be worked out in respect of the bank’s holding, such as buy-back by promoters, stake sale by the bank, with an option to the promoters to buy it up, and ideally exiting through an IPO by the company.

Financial gains

Besides the benefits mentioned, equity participation would fetch higher overall earnings for the bank than from extending only debt. With banks investing in the borrower company’s equity, the debt-equity ratio improves.

Due to the lower debt availed, substantial cash-flow savings shall accrue to the company, which would be adequate for buying back bank’s equity investments and pay dividends due meanwhile. If the bank opts for exit through listing of the shares, the cash gains would be significantly higher, both for the bank and the company.

Regulatory scene

The present regulatory guidelines and norms laid down by the RBI severely inhibit commercial banks’ exposure to capital market instruments. Investments in shares do not qualify for Statutory Liquidity Ratio (SLR). Banks have to ensure capital adequacy ratio of 11.25 per cent on their exposure to capital markets. The aggregate exposure should not exceed 40 per cent of the bank’s net worth and, within this, direct investment in shares should not exceed 20 per cent.

The Banking Regulation Act, 1949 stipulates that lending against and investments in equity shares shall not together exceed 30 per cent of the paid-up equity of the company or 30 per cent of the net worth of the bank concerned, whichever is less. There are also ceilings imposed by the RBI on lending against shares to a single borrower and groups.

Enabling banks to participate in equity

The merits and benefits of equity participation deserve early regulatory recognition. The current highly rigid norms and guidelines may be rationalised by the RBI, towards encouraging project-related equity investments by banks. About 60 per cent of the aggregate lendings of Rs 4,00,000 crore by banks to MCEs comprises project finance.

Applying a debt-equity ratio of 2:1, the equity component would amount to Rs 1,20,000 crore. To begin with, the RBI may restrict, at the macro level, the equity exposure of SCBs on MCEs to, say, 20 per cent of the estimated equity, or about Rs 24,000 crore, requiring each bank to accordingly set its own segmental cap.

This level is truly modest, about six per cent of the aggregate segmental credit. Gradually, with experience gained, the ceiling may be stepped up. A good majority of MCEs being unlisted entities, the proposed norms need to explicitly facilitate banks’ equity support to them, subject to exit options being available and such investments being confined to companies financed by the concerned banks.

In this context, the banks’ lending against listed shares constitute about 50 per cent of their capital market aggregate exposure. The RBI may consider, in view of the speculative potential of such loans, restraining banks from extending short-term credit facilities against shares and permit financing only genuine long-term investments.

The exposure space vacated by this move could provide ample room for equity investment by banks in MCEs.

(The author is a former General Manager of State Bank of India. Feedback to blfeedback@thehindu.co.in)

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