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Monday, July 21, 2014

India's New Bank Regulation for Long-Term Bond Issuance Is Credit Positive

Srikanth Vadlamani, Vice President - Senior Analyst and Nick Caes, Associate Analyst, Moody's Investors Service 

On Tuesday, the Reserve Bank of India, the country's central bank, announced new regulations for banks issuing long-term local currency bonds. These regulations are credit positive for the banks because they encourage them to issue longer-term debt by reducing its cost. 

Under the new regulations, long-term bonds (defined as those 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. Also, loans funded by this mechanism are exempt from the computation of adjusted net bank credit for the purpose of calculating priority-sector lending requirements. 

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 (Baa3 stable, D+/baa3 stable), Axis Bank Ltd. (Baa3 stable, D+/baa3 stable) and State Bank of India (Baa3 stable, D+/ba1 negative), and they would be the key beneficiaries of these norms. 

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 extent to which banks issue bonds under the new regulations will depend on the availability of a sufficiently large investor base. Banks' outstanding infrastructure loans and housing loans totaled INR11.4 trillion as of 31 March, while the total outstanding corporate bonds was around INR14.67 trillion for the same period. 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.
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