Bank lending to infrastructure projects has grown steadily over the last eight years, in part because of the government of India's focus on infrastructure development. Advances to the sector have grown to 15.5 per cent of banks' total industry advances as on March 31, 2005, from a meagre 2 per cent as on March 31, 1998. The sharp growth in infrastructure lending has enabled the issuance of infrastructure bonds, a new avenue for banks to mobilise resources. These bonds benefit banks' asset liability maturity (ALM) profiles, providing increased access to long-tenure funding.
According to Krishnan Sitaraman, head, financial sector ratings, CRISIL, "The proportion of long-term loans in banks' assets has grown to 45 per cent of total loans as on March 31, 2005, from less than 25 per cent as on March 31, 1998, driven by increased lending to the infrastructure and housing sectors. At the same time, however, banks are increasingly borrowing short-term, mainly to improve their margins. Given the hardening interest rates, CRISIL believes that this strategy is a risky one, as ALM mismatches have increased."
To offset ALM mismatches and encourage lending to the infrastructure sector, the Reserve Bank of India, in June 2004, permitted banks to raise long-term infrastructure bonds with a maturity of five years and above. These bonds can only be used to fund outstanding infrastructure loans with a residual maturity greater than five years. About 16.2 per cent of the total loans and advances of banks as on March 31, 2005 had residual maturities of more than five years. CRISIL estimates that the proportion of infrastructure loans with a maturity of more five years will be a larger proportion of total infrastructure loans.
However, most banks have not effectively leveraged this opportunity. To maintain profitability, they have instead continued to rely heavily on short-term borrowing (including certificates of deposit). In addition to the ALM mismatches, in a rising interest rate scenario the strategy of heavy reliance on short-term funding increases the pressure on banks to raise resources every year for meeting redemption requirements, more so in a high credit growth environment. In a situation where liquidity is tight, as it was during the second half of 2005-06, the cost of raising these resources increases. Infrastructure bonds can help banks avoid this danger.
CRISIL believes that infrastructure bonds present Indian banks with a Rs.200 billion opportunity Making use of this opportunity can help