To protect banks from traumatic losses caused by the sudden default by corporates and to ensure their better profitability, the Reserve Bank of India, on Friday, issued a discussion paper on curbing credit limits on corporate loans and requested feedback by April 30, 2015.
Starting January 1, 2019, RBI proposes to ask banks to cap lending to corporates at 25 per cent of their core capital, down from the earlier ceiling of 55 per cent. In its discussion paper, the central bank said the sum of all the exposure values of a bank to a single counterparty or to a group of connected ones, must, at all times, not be higher than 25 per cent of the bank’s available eligible capital base set by global standard-setter Basel Committee on Banking Supervision.
Commenting on the issue, VR Iyer, chairperson and managing director, Bank of India, said: “It is a positive move from the central bank to put a check on exposure limits. However, this will make things difficult for some sectors which require higher investments.”
Large cap banks have seen non-performing assets (NPAs) rise four-fold from 2.7 per cent of loans in FY09 to 4 per cent of loans in FY14. Fresh additions of NPAs have risen from 2 per cent of loans in FY09 to 2.7 per cent in FY14. The deterioration in the balance-sheet has led to a drop in earnings quality. Return on assets has dropped from 1.2 per cent to 0.9 per cent for large-cap banks.
The default of a borrower or a group of connected borrowers can cause a serious loss to a banking group. Hence, it is important to have an alternate sources of funding for the corporate sector, to finance growth, de-risk the balance sheets of banks as also to strengthen the balance sheets of the investors as well as the issuers, the RBI stated in its discussion paper.
In its efforts to deepen the corporate bond market, the RBI considers it desirable that large corporate groups should gradually start tapping the corporate bonds and commercial paper markets for meeting at least a portion of their financing needs.
Iyer added, “RBI will certainly allow banks some concessions for lending to few sector but with some riders.” The RBI proposes to encourage large borrowers to raise a certain portion of their financing needs through the market mechanism.