To deepen the nascent corporate bond market, the RBI today proposed allowing banks to provide partial credit enhancements to the debt instrument.
The central bank has released a draft circular on allowing partial credit enhancements to corporate bonds and invited comments from stakeholders by the end of next month.
"With a view to encouraging corporates to avail of bond financing, it has been decided to allow banks to provide partial credit enhancements to bonds issued for funding infrastructure projects by companies or special purpose vehicles," the RBI said in a release.
The objective of the move is to enhance credit ratings of the corporate bonds raised to set up infrastructure projects. It is also seen as a way of enabling companies to better access the funds from the corporate bond market.
Credit enhancement reassures that the borrower will honour the obligation. It reduces default risk and thereby increases the overall credit rating.
It said since the corporate bond market is in a nascent stage of development, there is a pressure on the banking system to fund the credit needs of the infrastructure sector.
The Reserve Bank of India (RBI) said because of asset-liability mismatch in infrastructure financing, banks are exposed to liquidity risks.
"The insurance and provident, pension funds whose liabilities are long term, are better suited to finance infra projects," the central bank said in the draft guidelines.
In July last year, the RBI had proposed allowing banks to offer partial credit enhancements to corporate bonds.
The RBI further said banks should have a board-approved policy on partial credit enhancements covering issues such as permissible types of credit enhancements, assessment of risk, and setting limits.
Banks should also have an overall exposure limit to the infra sector on account of their direct exposures by way of fund-based and non-fund based exposures to companies including NBFCs-IFCs, and indirect exposures by way of sponsoring IDFs and partial credit enhancements.
"Partial credit enhancement provided by banks shall be limited to the extent of improving the credit rating of bonds (assigned by a recognised external credit rating agency) by a maximum of two notches," RBI said.
As a credit enhancement, a bank can either provide a funded subordinated loan or a non-funded contingent line of credit, but not both.
The effect of the credit enhancement on the bond rating must be disclosed in the bond offer document - the rating of the bond without and with the credit enhancement should be disclosed, the draft guidelines said.
Partial credit enhancement facility may be extended to enable the corporates to access funds from the corporate bond market and not for availing finance from other banks or financial institutions.
The RBI, however, said banks should neither invest in the bonds for which they have provided partial credit enhancement, nor should they provide any other credit facility to the specific project or SPV.
It said the arrangement of banks providing partial credit enhancement to corporate bonds will be reviewed after a period of two years.