The price of de-risking

In an attempt to nip the bad loan crisis in the bud, the Reserve Bank of India has sought to cap banks’ exposure to large borrowers, who account for over half of banks’ lending and an alarming 86 per cent of the bad loans in the system. Given that a large share of corporate debt in India is concentrated in a few highly leveraged companies, tightening bank exposure to a single or group of connected borrowers not only mitigates the potential risk of financial instability, but is also a step towards aligning Indian norms with international standards, set by the Basel Committee of Banking Supervision. The new norms, which are likely to be implemented by March 2019, will require Indian banks to substantially cut their exposure to group borrowers, which currently can go up to 55 per cent (for funding certain infrastructure projects) of the bank’s capital. According to the new framework, banks’ exposure to single and group borrowers should not exceed 20 per cent and 25 per cent respectively of their Tier I capital.

The RBI has got off on the right foot, laying down limits on exposure in relation to a bank’s capital, which correctly takes into account a bank’s wherewithal to lend. But the new norms also propose to cap banks’ collective exposure to a ‘specified borrower’ in a phased manner to ₹10,000 crore from the start of fiscal 2020. While in theory this can help banks diffuse the risk emanating from a concentration of debt and improve asset quality, the move is nonetheless ill-conceived. For one, putting a blanket cap on banks’ exposure irrespective of borrower size or the nature of the project funded is hardly desirable at a time when infrastructure development requires massive capital. It is also a tall order for banks to drastically cut their exposure to large corporates, since many companies carry debt of over ₹30,000 crore. Given that meeting even the ₹25,000-crore limit by the end of this fiscal is suspect, penalising banks for failing to comply with these norms only makes matters worse. Banks will have to set aside an additional 3 per cent provision and higher risk-weights on loans extended to these corporates beyond the permitted limit. At a time when public sector banks are already saddled with huge losses and stretched for capital, these norms can do more harm than good.

The existing exposure norms in India have evolved as a result of the country’s developmental needs. Therefore, the RBI’s move to reduce dependence of large borrowers on banks will have to be supplemented by alternate funding avenues. The RBI has only recently announced a slew of big bang reforms for the bond market, which can go a long way in deepening the bond market. But it is still early days to bet on such reforms to do the trick on their own. As of now, the RBI’s new norms have ended up putting banks and highly indebted borrowers in a ‘Catch-22’ situation.

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