Regulating Large borrowers – RBI Proposal..

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As mentioned in another post, the NPA discussion has alerted the regulator further more to expedite regulations being under discussion for long. One that RBI has proposed last week, deals with large borrowers’ exposure to the banking sector as a whole.

The rules so far only dealt with a bank’s exposure to the corporate and always provided an opportunity to the corporate to approach another bank in case he has exhausted his limit from one bank.

RBI proposes to consider the whole banking system’s exposure to a corporate/ corporate group. As per the proposal, if the aggregate bank lending to the corporate goes beyond 50% of a defined threshold in a financial year, the banks providing the incremental fund will have to assign additional risk weightage of 75% to the particular loan. It will also have to make asset provision of 3% for such exposure against normal exposure of not more than 1% for most loans. The threshold has been put at Rs 25,000 crore for 2017-18 to be reduced to Rs 10,000 crore by April’ 2019 onward.

Risk weightage is an interesting and complex exercise mandated by banking regulators world over to be undertaken by all banks to control the impact of loan default. Each borrowing sector is assigned a specific risk weight by the regulator depending upon its past performance and probability of default and banks. For instance, housing loan has a risk weight of 50% whereas real estate loan have a risk weight of 100%. So, if a bank has, for example, 100 crore of exposure to housing loan and 200 crore to real estate then its risk weighed assets (RWA) is 0.5*50+1.0*200 = 250 crore.

Further, banks are required to maintain equity capital equal to 8% of the risk weighed assets (RWA). This ratio is called capital adequacy ratio (CAR), a key measure of bank’s vulnerability to loan default. A lower equity or higher RWA reduces bank’s ability to lend further even if it has funds available. So, when the banks are required to assign higher risk weight for the above mentioned lender, it will have to charge higher interest rate for such loan, to make up for the increased cost of equity and reduction in its ability to lend further.

The proposal from RBI, while looks quite stiff, does have merit especially considering the fact that there are corporate in India which are having loan exposure as much as Rs 50,000 crore and more..! Globally, these regulations are already in place.

However, the proposal will have to be supplemented by facilitating establishment of a robust corporate bond market, failing which, there could be a real crisis of funds once the economy starts booming, specially for mega projects in core infrastructure sectors.

(Image courtesy of renjith krishnan at FreeDigitalPhotos.ne)

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