It is somewhat surprising RBI has suggested that corporate bonds be included in the held-to-maturity (HTM) portfolio of banks’ investment books. Surely, not valuing corporate bonds regularly, but instead letting them sit on the books for years, cannot be a good idea? Given the numerous defaults by companies in the last few years—even those thought to be financially solid by our credit rating agencies—one would have expected the regulator would exercise much greater caution.
Indeed, as we have seen with mutual fund portfolios, the defaults can come from even the so-called highly-rated firms. We must remember that the credit risk on a government security is zero, but that on a corporate bond is not. No matter how well-rated a company, when a bank takes exposure to that company’s debt securities, it is taking on a degree of credit risk. To regularly re-adjust the valuation of corporate debt would ensure that the risk associated thereof reflects on banks’ balance sheets on an ongoing basis. Letting corporate bonds flow into a portfolio which is virtually insulated from a routine valuation exercise gives shareholders the short shrift. Indeed, it is a shame that all investments are subjected to a quarterly mark-to-market exercise. Obviously, the HTM mechanism is a sweetener to prompt banks to buy more government securities; that is needed to support the large borrowing programmes of the Centre and the states.
SEBI may want that big companies source a fourth of their annual borrowings from the bond market and, in the broader context, there is merit in wanting to deepen the market. However, this process must evolve over time, it cannot be forced. We cannot be pampering banks with easier regulation to get them to buy more bonds.
As we have seen repeatedly in the past, companies typically base their borrowing strategies on cost considerations more than on anything else. For much of the last two years, banks lost out on opportunities to give loans to corporates because the latter preferred to borrow from the money markets where pricing was finer. The abundance of liquidity in the markets led to private placements of corporate bonds rising a good 16.6% in 2020, to Rs 8 lakh crore. With banks offering attractive rates last year, they were able to entice companies to borrow from them; private placement of bonds fell to Rs 6.31 lakh crore in 2021. As such, there is no reason to believe that prescriptiveness works better than conducive market conditions in determining borrowing behaviour.
One of the unfortunate consequences of not having a deep enough bond market in India has been the lack of transparency in the market. Reports of unscrupulous fund managers cutting deals with bond issuers in exchange for investments, are not always without basis. Not surprisingly, most episodes of blowout in the mutual fund space have happened in the debt-fund space. Investors have found themselves carrying the can while fund managers of the schemes cashed out on the basis of privileged information. The IL&FS fiasco was another instance of a large interconnected institution defaulting on its bonds with investors having no prior inkling of what was about to hit them. Regulators should be insisting on more transparency, not more opacity. RBI has proposed that changes in the available for sale (AFS) portfolio be made through the reserves rather than through the P&L. One is not sure how well this will work. Banks might be encouraged to park a bigger share of paper in the AFS category. But again, from an accounting perspective, this may not be the best way to reflect the changes in the value. Banks have been given enough regulatory forbearance, it’s time they learn to play by the rules.