RBI has mooted the idea of creating a secondary market for bank loans in the latest credit policy. The idea already exists in modified forms for certain categories of loans. Impaired assets were being sold to other takers which could be institutions or ARCs.
RBI has mooted the idea of creating a secondary market for bank loans in the latest credit policy. The idea already exists in modified forms for certain categories of loans. Impaired assets were being sold to other takers which could be institutions or ARCs. Takeout finance, by its very nature, involves rolling over loans periodically from one bank to another. Securitisation is the packaging of loans, usually done in the retail segment to other banks and institutions. Hence, there is a secondary market for some kinds of loans.
The present idea can be interpreted as one where loans that are originated by a bank are sold to others at a later stage. There would be a difference in the interest cost as well as liability of the selling bank. These loans would be any kind of corporate loans of any rating and hence the idea is not restricted to impaired assets only. The options at this end can be explored.
The reason for a bank to sell loans can be for two reasons. The first can be that the bank would like to sell some loans to save on capital which can help it give other loans and hence churn its portfolio. Hence, too much exposure to the power sector can make a bank sell power loans and then originate loans for, say, electronics. Secondly, the bank may be interested in matching its asset and liability tenures. Therefore, a residual tenure of, say, 2 years may be sold so that capital is released and the same is deployed for a longer or shorter tenure. This can hence be a part of ALM management where deposit tenures are matched with those of loans.
For the buying bank, the reasons can be the same too, which will lead to intention matching. Further, at times, smaller banks may not be good at originating loans and hence would prefer to buy them from another bank so that the basic due diligence is done. Further, the buying bank would also like to take on a loan which has proved its credit worthiness over time and hence gets a lot of comfort from the fact that it is a tested exposure. To this extent, it can hold on to a cleaner portfolio of loans.
Therefore, creating a secondary market for corporate loans sounds like a good idea and, though not pervasive, does exist in countries like the US. It helps in better utilisation of capital and could also be lowering the quantum of risk taken by banks which have less expertise in certain areas. It may be pointed out that large loans are syndicated wherein a group of banks take on an exposure with the smaller ones pecking in with smaller amounts and hence riding on the expertise of the others. It is not uncommon to have smaller banks tagging on to larger ones with the belief that the loan is a good one. A secondary market will be an extension of this practice.
Should the market be an OTC or a market-based platform? A market-based platform would be preferred finally, though, to begin with, an OTC approach is advisable as banks can make their deals and then report to the CCIL or any other reporting authority. Here, the bilateral deals may tend to have distorted pricing and a market platform will actually help in better price discovery. It may be mentioned here that it did take time before the derivatives market developed in forex, which has historically been a forwards market on the OTC platform. A market platform can get in more players and the universe will hence not be restricted to just banks but also other NBFCs, HNIs, FIs, infra funds, etc. The churning of the loan multiple times will help in deepening the market and lead to better price discovery which does not happen today as, invariably, all loans are fixed unilaterally by the bank in a situation where the large ones with a dominant presence become the price setter.
How does one choose the asset? Here, a credit rating will be critical and, hence, just like the corporate bond market has the concept of independent credit ratings being mandatory, so should it be for loans being sold in this market. It has to come from the rating companies and not banks, which have their internal rating, as there would be an incentive to overstate the quality of the asset by the selling bank. This can be a leading indicator for price discovery or else it will be hard to distinguish between loans. Presently, credit ratings ignore the collateral value and, hence, a different rating scale may be considered where the value of the collateral is also reckoned, just like it is done for loans against property or gold.
What about a cover for defaults? While the IBC exists and the lender can take the borrower to court for settlement, this would also be an opportune time to bring in the CDS and make it compulsory. The CDS has been a non-starter in the bond market and by making it mandatory in the secondary bank loan market, the concept can crystallise from the amorphous form it is in today. In fact, the CDS is a powerful tool for risk management in the bond market as it provides security against defaults where the writer comes in and provides cover. Once successful here, it will feed back to the bond market and help in growing the same, something that has been the objective of the government, RBI and SEBI in the last couple of years.
Are there any risks to this model? The existence of a secondary market and the buffers of ratings and CDS can lead to higher risk taking by banks, which originate loans knowing very well that it can be sold off on the platform. Also, there can be a case of giving more teaser loans to garner business and meet targets as they can be sold and capital can be churned. This cannot be ruled out, and this was the case when the financial crisis took place in the West where financial engineering of a different sort (CDOs, MBS, CDS, etc) led to higher levels of funding which eventually collapsed. Therefore, strict regulation is the order of the day and should be pursued by RBI to ensure an orderly development of this market.
Anecdotally, it has been seen that there has been a positive correlation between the turnover in the secondary market for loans and performances by companies. In the conventional model, the discovery of a NPA is often left opaque while, in cases of bonds, it comes out in the open. Therefore, companies have an incentive to perform better and keep away from defaulting. Quite surely, this idea will add value to the bank loan market once formalised and introduced by RBI.
The writer is Chief economist, CARE ratings Views are personal