In a laissez-faire economy, companies should be allowed to borrow from whichever lenders suit them the best in terms of the rates and tenures. At no time should companies be compelled to borrow from one source or another; this decision should be left to the board and the management because they are answerable to shareholders. To that extent, the government’s proposal to make it compulsory for large corporates to borrow a fourth of their funding needs from the bond markets is regressive and smacks of high handedness. The banks may want to restrict exposures to certain companies and they are free to do so; indeed, this newspaper has argued for years now that the prudential guidelines put out by RBI for lending to companies and business groups were far too liberal and one of the main reasons why banks have been saddled with non-performing assets. RBI’s argument has been that industry needed to be supported and the larger groups were the best-positioned to put up large projects. While banks could lend up to 15% of their capital to individual firms and 40% to groups—this could rise to 25% and 55% after taking relaxations for infrastructure—RBI changed it to 20% and 25% in December 2016. Since bank liabilities are typically of a short-term nature—the bulk of deposits are in the two-three year bucket—ideally, they should not be taking on long-term exposures because it creates an asset-liability mismatch. With the benefit of hindsight, higher exposure limits for India Inc was clearly a policy decision that played out badly for the banks.
However, attempting to boost the bond markets by forcing companies to borrow here is the wrong way to go about it. At 51% in 2016-17, the share of the bond market in financing companies was larger than that of the banks. The interest rates were lower and foreign portfolio investors (FPI) were buyers, supplementing purchases by mutual funds and insurance companies. What is more, banks, too, were participating in bond purchases. This, then, proves that the bond markets don’t need to be pushed by mandating companies to borrow from them. Since the provisioning norms for incremental lending on large exposures of banks have been tightened, there is a good chance companies will in any case migrate to the bond markets. The government, however, is right in suggesting institutional investors be enabled to invest in paper that is rated below AA. Even lower-rated companies can, at times, make for reasonably safe investments and those investors willing to put their money in junk bonds should be allowed to do so. Credit enhancement products should help investors. Moreover, as SEBI points out in its discussion paper, given the IBC is now operational, it can’t hurt to do away with the debenture redemption reserve (DRR). All that the government needs to is to frame rules that are friendly; it must leave the rest to market forces.