Insights into Editorial: The case for long-term finance banks
As the financial sector grows, apart from a number of universal banks, experts say it may be useful to have differentiated banks focusing on different areas and developing competence. In this context, RBI recently published a discussion paper on the need for wholesale and long-term finance (WLTF) banks. The move comes exactly a year after former RBI governor Raghuram Rajan proposed a new category of lenders to take over the burden of financing long-term projects from commercial banks.
What is a WLTF bank?
It will be a combination of term-lending institution and an investment bank. Promoters eligible to apply for banking licence can apply. However, minimum capital proposed is Rs 1,000 cr. while they can’t accept savings deposits, they can raise money from current accounts, bulk fixed amounts and bonds.
WLTF is the third category of a differentiated bank licence. The RBI has already issued differentiated licences for payments banks and small finance banks.
Need for specialised banks:
- Presently, it’s not easy for companies to get long-term financing because of the underdeveloped corporate bond market and possible asset liability mismatch in the banking system.
- The banking system is also saddled with non-performing assets (NPAs), and a large portion is concentrated in the infrastructure sector.
- The financial sector has also not been able to meet the scale or sophistication of the needs of large corporates, as well as public infrastructure, and does not penetrate deeply enough to meet the needs of small- and medium-sized enterprises in many parts of the country.
Scope of activities:
- WLTF banks focus on lending to the corporate sector, small and medium businesses, and the infrastructure sector.
- They may also offer services in the area of foreign exchange and trade finance.
- They can act as market makers in instruments like corporate bonds and credit derivatives.
- The banks can also raise funds through issuance of debt and equity. They may also be allowed to accept term deposits above a threshold.
- Besides providing long-term loans, it is envisaged that WLTF banks will act as market-makers on corporate bonds, credit derivatives, warehouse receipts and provide takeout financing. They will also provide investment bank services related to equity/debt investments and forex and trade finance to their clients.
- Apart from these, there is a gamut of specialized services that these banks can offer to Indian businesses.
Benefits of having WLTF banks:
- They reduce the cost of intermediation and lead to better economic outcomes.
- As specialized institutions, they will be in a much better position compared with commercial banks in evaluating and funding long-term projects.
- With specialized banks, NPA risks could possibly be avoided in the future.
- It may also help the rest of the banking sector in the case of joint lending, or by simply getting the project evaluation from these banks.
- Establishment of WLTF banks will also enhance competition, which will lead to more efficient allocation of financial resources.
Things that need to be ensured for these banks to succeed:
- Government participation in setting up WLTF banks should be avoided as it could end up defeating the purpose. Government ownership would lead to the same problems that public sector banks are facing at the moment. Further, these banks will be highly specialized and will need operational freedom, which is not possible with government ownership.
- Licences should only be issued to entities that are able to demonstrate the ability to build such a highly specialized bank, and are in a position to bring in capital to both meet regulatory requirements and run the business on a sustainable basis. The central bank may allow industrial houses to participate to the extent that they are not in a position to influence business decisions.
- The RBI will need to design a regulatory architecture that will enable growth with adequate safeguards. For example, the regulator may choose to exempt these banks from cash reserve ratio and statutory liquidity ratio requirements. These banks will compete directly with the bond market.
- Having bricks-and-mortar structures would add to costs and hence the option of being primarily an internet based bank can be considered.
- The WLTF banks can be made to apportion lending activity across both credit and debt markets. A 50-50 division will be useful as they can lend directly in the bond market for bonds which will be higher-rated. This will also be the preferred route for higher-rated companies. The balance lending should be based on collateral with insolvency laws in place. Also, RBI should focus simultaneously on credit enhancements to be provided by banks on such bonds which may be subscribed by the WLTFs.
- The WLTF banks should be freed completely from CRR and SLR obligations. The CRR is a disincentive while SLR will make them gravitate towards G-Secs.
- RBI can set tenures for their lending, i.e., not less than five years or such a norm, but should give the freedom to lend to any sector. Bringing in priority-sector-like norms will impede their activity.
It should be remembered that WLTF will be starting with the handicap of lending to the non-retail segment and taking on higher risk as these loans would be of a long tenure. Focusing on infra projects and term-lending makes FIs more vulnerable to NPAs and hence, prima facie, the last decadal developments are a dampener. In short, there should few inhibiting clauses in the terms of engagement for these banks, or else potential promoters would be at a disadvantage. An issue which should be kept in mind while giving permission is that all banks—including private sector—ones have faltered on asset quality when such long-term lending is concerned.
Well designed WLTF banks with right kind of ownership will go long way in helping the financial sector of the country. With right regulatory architecture, these banks will help improve efficiency in the financial system and enhance the flow of credit to businesses with large and long-term financing needs. The pitfalls in the earlier dispensation of DFIs need to be addressed in detail by the applicants to reassure the central bank that these models can work.