Secondary loan mkt may completely change India's banking landscape: Experts

Topics loans | Bank loans | Banking sector

The report of the task force on secondary loan market for India could completely change the banking landscape in the country for better, if taken seriously and implemented properly, but it also runs the risk of being another report such as those on developing the bond market in India that never implemented fully.

The recommendations of the latest report, released by the Reserve Bank of India (RBI) on Tuesday are “ahead of its time,” say experts, but are doable and the way forward. 

“In India, they have not been able to develop a serious secondary market for corporate bonds. It is difficult to develop the secondary loan market,” said a senior banker requesting anonymity. 

But then, according to another expert in the field, “the secondary loan market could herald a new corporate bond market. The loans being traded would be rated, and notified on exchanges. A corporate bond market could develop following the lead,” said another expert. 

Whatever the case may be, there are steep challenges ahead and important ramifications for the existing players. 

In India, there is a well established secondary market for stressed loans. There are asset reconstruction companies (ARC), and securitization deals done by the non-banking financial companies (NBFC), even as recently the RBI allowed banks to sell their stressed assets directly to foreign investors abroad. 

However, there is no formal system of buying and selling the loans. The transactions are done over the counter and on a bilateral basis. What the task force suggests is that there should be an online platform where rated loans can be traded. The task force also recommends that the existing laws be amended to enable mutual funds, insurance companies, and even foreign portfolio investors (FPI) to buy the loans. Right now the market in India is limited to banks and NBFCs trading between themselves.

Foreign investors participate in distress debt via the ARCs. 

“Internationally, secondary loan market is utilized by diverse and vast number of participants including investment banks, commercial banks, hedge funds, pension funds, loan mutual funds, insurance companies, private equity funds and specialist loan brokers,” the task force said in its report, adding that in the Indian context too, there is a need to boost the secondary market by widening the spectrum of participants. 

While scheduled commercial banks are expected to actively participate in the proposed secondary market, other players including NBFCs, ARCs, public financial institutions, insurance companies, pension funds, mutual funds, alternate investment funds (AIFs) and FPIs registered with SEBI should also be permitted to participate in the market “to provide liquidity and ensure orderly development of the market,” the task force report said.

Interestingly, for FPIs, the report suggest that such investments by FPIs should be under voluntary retention route (VRR), under which the FPI can voluntarily commit to retain a required minimum 75 per cent of their investments in India for a period of three years. 

Experts say the secondary loan market can corner about 60 per cent of the total loans in just three years, if there is concerted effort in taking the recommendations seriously and changing the eco system.

A major challenge can come from the taxation side. Say for example, if a loan is bought at say 80 per cent of the value that the bank had sold at, the income tax department may argue that 20 per cent is the gain and is taxable, or if the asset is bought at a premium, the tax authorities may raise questions, said a senior executive with an ARC. 

Accounting would be another big challenge.

The report itself raises questions about simplifying stamp duty and other taxes to enable the online trading platform to take off. The platform, meanwhile, has to be developed and monitored by the Reserve Bank of India (RBI). 

Once started however, about 60 percent of the entire loans of banks can migrate to the secondary market trading platform in just three years, say experts. 

“It is immensely doable. But will take years to implement all changes,” said the banker quoted above.  

But there are other issues. For example, the loan market may end up severely punishing the public sector banks for their inefficient loan pricing. 

“There are mostly legacy challenges. The loans are mispriced in India. If secondary market develops, banks have to very smart,” said the financial expert requesting anonymity.

Suppose a bank has given a loan at 8 per cent, but the market determines that the loan should have been given at 10 per cent. The bank immediately will have to book mark-to-market losses on its loan portfolio. This pushes up provisioning in term till banks become efficient in pricing loans.

ARCs, meanwhile, may get majorly hit as FPIs and others can now directly buy the stressed loans, if the task force recommendations are accepted. 

But an ARC official said the market is huge and there is scope for everybody. 

“The issue in India is not competition, but funds. If more investors come, more efficient the market would be and everybody will end up benefiting, including ARCs, who, frankly, desperately want the pricing to be fair for assets,” said the executive. 

However, right now public sector banks would be busy with their merger preparations and may not have time to become a market maker in such secondary loan market. But after about two years, when the big banks complete their integration process, things could be very different.

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