De-risking

The RBI’s proposal to tighten bank exposure to a single or group of connected borrowers is a step towards aligning Indian norms with international standards on large exposures set by the Basel Committee of Banking Supervision. The new norms, which are likely to come into effect from 2019, will require Indian banks to substantially cut back their exposure to group borrowers, which, under the existing practice, can go up to as much as 55 per cent of a bank’s capital. According to the new framework, bank exposure to both single and group borrowers should not exceed 25 per cent of the Tier I capital. The review of exposure limits comes at a time when the sector is grappling with alarming levels of bad loans and restructured assets. The lacklustre performance of the corporate sector is worrying, and defaults by large corporates can result in huge losses for the banking system.

According to the RBI’s 2013 Financial Stability Report, the failure of a large corporate group can result in a total loss of over 60 per cent of the banking system’s capital, if the loss given default — the actual loss that a bank will experience when a debtor defaults — is assumed at 100 per cent. This is because, aside from the direct loss, the failure of a group can also trigger contagion risks, leading to substantial losses. Large banks in India carry a high concentration risk. In the case of SBI, India’s largest lender, the share of 20 largest borrowers in total loans was about 18 per cent or over ₹2 lakh crore in 2013-14. Given that SBI’s share in overall bank lending is over a fifth, this figure is far from comforting. Capping large exposures is also in alignment with the Basel Committee’s risk-based capital framework, which assumes that a bank has minimal concentration risk while ascertaining capital requirements.

That said, the existing exposure norms in India have evolved as a result of the country’s developmental needs. Raising adequate resources for infrastructure development is critical and hence the RBI’s move to reduce the dependence of large borrowers on banks will have to be supplemented by alternative funding avenues. The RBI has nudged corporates to move to the corporate debt market to raise funds. But to serve as an efficient alternative source of funding, the regulator and the government will have to ensure a more vibrant corporate bond market. The RBI’s gradual reduction of SLR requirements is a step in the right direction as it will do away with a captive market for government securities. There is also a need to develop market makers, similar to the primary dealers in the government bond market. This will improve the liquidity of bonds in the secondary market. Relaxing investment norms for pension funds and insurance companies will enable more issuances of lower-rated corporate bonds. There is now an urgent need to boost the corporate bond market, lest large infrastructure companies end up with fewer funding sources to tap.

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