MUMBAI: The Reserve Bank of India (RBI) working paper on prudential standards for banks’ investment portfolio, if implemented, is expected to bring about structural changes by allowing corporate bonds to qualify for the held-to-maturity (HTM) portfolio, said India Ratings and Research.
The proposed inclusion of corporate bonds will catalyze bank investments in corporate bonds, especially long-term bonds, he said.
The rating agency believes that there will be major challenges if corporate bonds are cleared in HTM. First, HTM provides for the exclusion of the regular brand in the market; therefore, if credit quality deteriorates, notional losses may increase disproportionately.
In accordance with the working document, an impairment test will have to be carried out on a quarterly basis and if any impairment is found, it will be debited from the profit and loss (P&L) account. India Ratings said that to avoid such phenomenon, certain rating restrictions through a minimum rating threshold are required to trigger go-to-market and subsequent alignment with market-based pricing.
Second, the HTM in corporate bonds will reduce the stock of corporate bonds to trade, thereby affecting market liquidity, he said.
“Overall, the corporate bond market plays a key role in the financial system; a dynamic corporate bond market ensures better credit underwriting and efficient market mechanisms. Although market-based financing is more sensitive to the vagaries of the capital market, it does not outweigh the benefits of a developed bond market,” he said.
According to the rating agency, with the changes in the conventional lending landscape due to the fintech revolution, borrowers and investors are looking for more financing options in the capital market. In such an environment, boosting banks’ push for corporate bonds is a welcome move, he added.
Existing Indian standards only allow securities issued by central government, state governments and certain infrastructure companies to be held in the HTM category, up to 25% of total investments. The new standards, however, propose to include corporate bonds along with existing securities that are permitted in the HTM category with the removal of the 25% limit for this category. India Ratings said it expects this to boost momentum for banks to invest in corporate bonds. Corporate investors largely focus on insurance and pension funds, followed by mutual funds.
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