Column: Is future of financial reform here

Written by Subhomoy Bhattacharjee | Updated: Jan 28 2010, 02:23am hrs
RBI has made some big changes this month. We have already seen extension of currency futures market to include three more currency pairs, the roll-out of the rules for a corporate repo market and a somewhat less noticed permission to float subordinate debt to retail investors by banks.

On the next mile, are plans to introduce currency options, the natural extension of the currency futures market. One will really have to scan back long and hard to find out a comparable period when RBI moved so fast to introduce so many changes in the financial market, designed to open them up.

Taken together they are the biggest pack of liquidity enhancers for banks (FIIs and others have been kept out of some of these markets for now). This is about more than arcane money-making operations for players in the financial markets.

On Monday, SBI announced it had suffered a Rs 450 crore loss from its treasury portfolio. Last Thursday, ICICI Bank too wrote down Rs 26 crore from its portfolio against a profit of Rs 976 crore the year before. In this season, several other banks will come out with equally bad hits to their bottom line. The culpability lies with the government as its huge borrowing pushed up yields, and lowered prices of the papers the banks held, through this fiscal.

The new markets that will now come up will give the treasury managers of these banks the chance to offset the losses in government treasury operations with possible profits in corporate papers. Just as the rest of the world is discovering the virtues of old fashioned 3-6-3 banking, Indian banks are realising it is impossible to make the balance sheet sing with that formula. Just as 2007-08 was the year for massive profits from treasury operations, where credit managers just shut their books and went home, the year 2009-10 is turning out to be a nightmare. In that scenario, as one of the managers at a private bank that managed to book profit despite the volatile market explained, corporate debt market need not be played as a mirror image of the government securities market. In other words, there can be far more flexibility in that market. Opening up the market for corporate repo means banks will be able to earn liquidity from the corporate debt papers they are now sitting on. In the absence of a market for corporate repo, these papers were basically locked in the bank vaults. Because there was no liquidity stemming from these papers in the short run, banks in turn were reluctant to invest in the papers. So, companies had a problem when they wanted to float such papers as the buyers, typically banks wanted a higher rate of interest to compensate for the fact the papers had to be held to maturity.

But typical of the caution that RBI always couples with new developments, all these come with big caveats. The market for corporate repo will be an over the counter (OTC) market. What was needed was to make the market an exchange traded one. But here is a turf issue. An OTC market will be run by RBI, the exchange traded one would have passed under Sebi. So we have a queer situation, where equity markets of companies are handled by Sebi, the companies will also raise debt as per Sebi rules, but the subsequent market for those papers will be run by RBI. FIIs have, therefore, been kept out of the market.

The other spanner RBI has thrown in is the 25% haircut in the pricing of the papers. This is a substantial margin that the banks will have to account for. Fixed income market managers are convinced this is a steep margin and could considerably reduce the interest of the banks to place the papers in the market. It will be interesting to watch if despite these hiccups, the market picks up as robustly as the currency futures, where just with one pair the volume of trade has touched $7 billion on some days.

On subordinate debt to retail investors RBI has rightly said the banks must not use their fixed deposit rates as benchmark to price the new paper. No cavil with that just as it is quite proper to ask the issuers to explain to borrowers the difference between buying a subordinated bond and a fixed deposit, basically that bonds are not covered by deposit insurance. Though the Indian version of the application of the too big to fail phenomenon means no bondholder really needs to be worried on that score.

The steps had, of course, been listed in the second quarter monetary policy statement of the RBI governor, D Subbarao. In a speech to the FIMMDA he had also said the current turmoil in the global markets should not detract from the need to bring in reforms in the financial markets. But the pace at which RBI usually moves had made most of us assume that all this was further into the future than it turned out.