Rating agency Moody’s said the Reserve Bank of India’s new guidelines on exempting long-term from reserve requirements will allow banks to compete more effectively in the infrastructure loan market.
“The new regulations are also likely to foster an improvement of banks’ competitive positioning vis-à-vis housing finance companies and infrastructure finance companies, because the banks’ lower cost of funding allows them to be much more competitive on pricing. This is especially relevant for plain vanilla mortgages, where price competition is already intense, forcing housing finance companies to operate with thin margins,” the agency said.
On Tuesday, the Reserve Bank of India said bonds with a tenor of more than seven years are exempt from cash and statutory reserve requirements as long as the bond proceeds are used to fund new long-term infrastructure projects and affordable housing.
Cash and statutory requirements refers to legal obligations that the RBI places on banks to keep apart a certain portion of their loans and exposure in liquid and secure forms such as government bonds, cash etc..
Not having to do this for a specific category would help banks increase their exposure to that sector without having to also park funds in low-return investments for complying with RBI rules.
“By exempting the bonds from cash and statutory reserve requirements, the central bank is effectively incentivizing banks to issue the bonds by reducing their costs. Although banks have been allowed to issue long-term domestic debt since 2004, issuance has been scant because it was not economical for them. The banks with the greatest exposure to infrastructure and mortgage loans are ICICI Bank Limited, Axis Bank Ltd, and State Bank of India, and they would be the key beneficiaries of these norms.”
However, Moody’s also said that banks would lend to these sectors only if they are able to raise more funds.
Indian banks’ exposure to real estate sector is already very high. They had outstanding infrastructure loans and housing loans totaled INR 11.4 trillion as of 31 March, while the total outstanding corporate bonds was around INR 14.67 trillion for the same period. A downturn in prices would seriously stress their assets and possibly force many banks to go under.
“The extent to which banks issue bonds under the new regulations will depend on the availability of a sufficiently large investor base. Given banks’ huge potential issuance compared with the current size of the corporate debt market, the extent of bond issuance under the new regulations will depend on the availability of an expanded investor base including foreign institutional investors.”