RBI proposes market-based rates for over-leveraged corporate borrowers

Reserve Bank of India (RBI) is planning to put in place a market-based lending mechanism in order to limit banks' exposure to highly-leveraged corporate borrowers whereby banks would charge higher interest rates on borrowings beyond permissible limits depending upon the risks involved

RBI on Thursday released a discussion paper on the proposed a framework under which banks will follow the market mechanism for enhancing credit supply for large corporate borrowers.

RBI noted that the absence of an overarching ceiling on total bank borrowing by a corporate entity from the banking system has resulted in banks collectively having very high exposures to some of the large corporates in India. The proposed framework is intended to mitigating the risk posed to the banking system on account of large aggregate lending to a single corporate.

The proposed framework will come into effect from the financial year 2017-18 and will be applicable to all banks in India as well as branches of Indian banks abroad. Under the proposed framework, borrowings of the 'specified borrowers' having a certain aggregate sanctioned fund-based credit limit (ASCL) from the banking system beyond the Normally Permitted Lending Limit (NPLL), will invite additional risk weight and higher standard asset provision.

The new measure is also intended to encourage large corporates to look beyond bank credit for term finance needs.  This would help to revive the corporate bond market, which has been dormant for quite some time now.

In March 2015, the RBI had released another paper, titled Large Exposures Framework and Enhancing Credit Supply through Market Mechanism. The paper had focused on the need to encourage sources of funding other than bank credit for the corporate sector to finance growth. Specifically, it proposed ways to encourage large corporates with borrowings from the banking system above a cut-off level to tap the market for their working capital and term loan needs. RBI issued the latest paper based on comments from stakeholders and after examining several options to enhance credit supply through the market.

According to the RBI paper, the risk recognition measures will be in the form of additional standard asset provisioning and higher risk weights by banks for a specified borrower.

RBI said an analysis of the indebtedness of 77,036 borrower companies with aggregate sanctioned credit limits of Rs1 crore and above at the end of December showed that large corporates are excessively leveraged and the banking sector's aggregate exposure towards such companies is also very high.

This poses a collective concentration risk for the sector, even when the single and group borrower exposures for each bank remain well within the prescribed exposure limits.

The banking system will ordinarily have to keep its future incremental exposures to the specified borrowers within the Normal Permitted Lending Limit (NPLL).

The paper proposes that there be a standard asset provision of 3 per cent on the incremental exposure of the banking system in excess of NPLL, which will be distributed in proportion to each bank's funded exposure to the specified borrower.

It also proposes an additional risk weight of 75 per cent over and above the applicable risk weight for the exposure to the specified borrower.

''The resultant additional risk weighted exposure, in terms of risk weighted assets, shall be distributed in proportion to each bank's funded exposure to the specified borrower,'' said the paper.