Corporate bonds

RBI Investment Corporate Bonds: Proposed Changes to RBI Investment Standards to Usher in Structural Changes in the Bond Market: Report

Mumbai: The proposed revision of prudential standards for banks’ investment portfolio by the Reserve Bank will bring about structural changes in the system by allowing corporate bonds to qualify for the held-to-maturity portfolio ( HTM), if implemented, according to a report by ratings firm Ratings of India.

“The proposed inclusion of corporate bonds will catalyze bank investment in corporate bonds, particularly long-term bonds,” said a report from the ratings firm.

The agency believes that there will be major challenges if corporate bonds are permitted 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.

The central bank‘s working paper says an impairment test will need to be performed on a quarterly basis and if any impairment is found, it will be charged to the income statement. To avoid such phenomenon, certain rating restrictions through a minimum rating threshold are required to trigger mark-to-market valuation and subsequent alignment to market-based pricing, according to India Ratings.

Additionally, the HTM in corporate bonds will reduce the stock of corporate bonds to trade, thus affecting market liquidity, he said. Globally, 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 advantages of a developed bond market. Additionally, 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, the push for corporate bonds is a welcome move, India Ratings said.

The RBI’s working paper on the new standards suggests that the investment portfolio of banks should be classified into three main categories, namely (1) HTM, (2) Available for sale and (3) Fair value by market. through the profit and loss account.

The Fair Value through Profit and Loss category will also include a Held for Trading sub-category which aligns with the specifications of “Trading Portfolio” under the Basel III framework. The HTM category will include debt securities with fixed or determinable payments and fixed maturity with the intention of holding them to maturity, including non-SLR (statutory liquidity ratio) securities (corporate bonds).