Atul Joshi, former banker and now managing director & CEO of India Ratings and Research, the Fitch Ratings vehicle, is not the one to fret like the entire banking industry is over bad loans and capital generation. A silver bullet is available for banks: just issue senior, unsecured bonds. In this first of a two-part interview with Raj Nambisan and Parnika Sokhi, he explains the remedy.
Why the continuously scarce liquidity in the banking system?
It’s primarily the huge mismatches in asset-liability with systemic current account – savings account (Casa) approaching government holding levels in banks. Also, the funding of infrastructure is happening out of lower-maturity liabilities. If this is not addressed over the next 3 years, we will be running massive liquidity issues. The one-year liability to total liability has gone up to 48% at the system level…
That’s like the banking system runs on one-year money!
… and one-year loans to total loans has come down from mid-30% to mid-20% — they have literally crossed each other on the graph, and are headed in opposite directions. Liabilities are higher, assets are lower. That balance sheet is no longer self-matching, and that’s reflected in the high liquidity adjustment facility borrowings. This is a structural asset-liability management issue.
The banking sector’s exposure to infrastructure is 14% … and where are the instruments?
So what’s the way out?
There’s one. Banks must issue senior bonds.
Unsecured, but senior.
What about duration?
It should be a minimum 15 years, preferably fixed. Nobody has done it in the rupee segment, though some banks have done it in the offshore segment. No bank is probably thinking on the lines that it can issue senior bonds of 15- to 30-year maturity. Till such time Basel-III-complaint bonds draw market appetite, banks should issue senior bonds to get out of the liquidity trap.
What about the regulations?
The regulations are silent, but nothing prevents issuances because already there are such instruments in the banks’ books as other liabilities. Some banks which have offshore branches have set up their MTN programmes. Regulations are silent on onshore and offshore. What is prohibited onshore is prohibited offshore. So there is no problem with this…
Is there investor appetite for them?
People are asking for it. We had one conference in Delhi in November, where we had Canadian pension funds. They are seriously bulge-bracket, big, big moneybags, and are looking at 30-year papers to invest. Not 25, only 30. The appetite is there, it is only a question whether banks would issue. Even if one bank takes the initiative, it will open the floodgates.
There could be rating issues?
The rating will not be notched down, which would be the case if these were hybrid or perpetual bonds. Senior bonds will have the same rating as the issuing bank’s. The bonds will not have the advantage of being capital, but it would correct structural mismatches in bank balance sheets. And it will be cheaper compared with an upper Tier-II and perpetual because it is senior.
You mean in terms of lien?
Absolutely. And it could substantially mitigate liquidity issues. It will have an impact on infrastructure bad loans too. Banks don’t have 15-25 year money, so they are funding infrastructure projects with 7-9 year money. The payback timing of infrastructure loans is 15-30 years. The moment their funding is repayable over a longer period of time, their ratings will improve. Banks are ‘BB’ and ‘BBB’ only because of the funding profile. The moment they get longer-term funds, their ratings just take off, which means banks will have to provide for lower capital.
Have you spoken to banks on this?
I have, and they asked me, under which regulation can we issue? I said under which regulation have you issued offshore bonds? Senior bonds are not concerned with capital. It’s an instrument that will help the banks rectify their asset-liability mismatches, and give them longer-term funds. The tap for upper Tier-II and perpetual is closed now.
Can that bridge the Rs1 lakh crore+ of — what seems to be near-structural — liquidity gap?
Yes. Right now, they are funding liabilities through deposits of 1-3 years. I think in the first year, they should be able to raise anything between Rs50,000 crore and Rs1 lakh crore. Many investors would be interested because these will not have features like deferral of interest payment. These are just vanilla bonds. The investors could be mutual funds, FIIs, provident and pension funds and insurance companies. It will also improve the yield curve transparency.
Can that rectify the out-of-whack yield curve? But then again, where’s the bond market depth?
The first thing is, the government needs to move the benchmark from 10 years to 30 years. If I have to price a 30-year bond, I do not have a gilt reference that is liquid. People have been talking about the development of India’s corporate bond market for ages. I think the starting point is the issuance of 30-year benchmark sovereign bond. Right now, banks have addressed the interest-rate risk but have not addressed the liquidity risk. They are essentially doing an interest-rate reset because they have borrowed short to fund long. They can create a balance sheet hedge by lending long on a fixed-rate basis.
What about interest-rate hedge?
Borrowers can create a floater anytime by doing an interest-rate swap. Once banks issue senior bonds, corporates will also get a reference curve. And before you know, the corporate bond market can develop and foreign institutional investors can come in big time.