- Ten major lenders, including State Bank of India, ICICI Bank, Canara Bank and Standard Chartered Bank, have for the first time joined hands to set up an online platform for trading of corporate loans in the secondary market
- Called the Secondary Loan Market Association (SLMA), it has been formed on the recommendation of the Reserve Bank of India’s Task Force on the Development of Secondary Market for Corporate Loans.
- State Bank of India, ICICI Bank, Canara Bank and Standard Chartered Bank, Kotak Mahindra Bank, Deutsche Bank, Bank of Baroda, Punjab National Bank, Axis Bank and HDFC Bank are members of Secondary Loan Market Association
According to the RBI Task Force report, an active secondary market will deliver significant benefits to banks in the form of capital optimization, liquidity management and risk management. This would, in turn, lead to additional credit creation at the economy wide level.
The recent Financial Stability Report of the Reserve Bank of India (RBI) reiterates the need for an active secondary market for corporate loans. It would lead to diversification of credit risks, provide market-based credit products for a diversified set of investors, and, generally speaking, boost transparency in banking.
And, in institutionalizing a secondary market for corporate loans, RBI has duly helped set up a self-regulatory body (SRB), termed Secondary Loan Market Association, consisting of market participants.
Background
The Reserve Bank of India (RBI) constituted Panel in 2019, headed by T.N. Manoharan, has given some suggestions for developing the secondary market for corporate loans in the country.
Purpose of Task Force
In India's context, corporate loans both standard and Non-Performing Assets (NPAs) have been transferred from banks to other lenders and Asset Reconstruction Companies (ARCs).
- However, this inter-bank bilateral transactions of loan accounts have been relatively infrequent.
As regards the securitization market, it has mostly evolved in the retail segment and there has been no major breakthrough in the corporate portfolio.
To overcome these hurdles, the RBI constituted a task force to examine the development of secondary market for corporate loans and make recommendations to facilitate rapid development of this market.
Suggestions of constituted Panel are as follows:
Setting up a Self-Regulatory Body (SRB) of participants to finalize details for the secondary market for corporate loans, including the standardization of documents.
Creating a Loan Contract Registry to remove information asymmetries between buyers and sellers.
- Creating an online loan sales platform to conduct auctions and sale of loans.
Widening the Spectrum: Enabling participation of non-banking entities such as mutual funds, insurance companies, and pension funds.
- Banks and the Non-Banking Financial Companies (NBFCs) are currently the only participants in the primary and secondary loan markets.
Single loan securitization can be considered to incentivize investors to acquire loans through the secondary market mechanism.
- Securitization is currently permitted only for a pool of homogenous assets.
- Securitization is a process by which a company clubs it's different financial assets/debts to form a consolidated financial instrument which is issued to investors. In return, the investors in such securities get interest.
Allowing Foreign Portfolio Investors (FPIs) to directly purchase distressed loans from banks.
- Currently, FPIs have to come through the Asset Reconstruction Companies (ARCs) to participate in the distressed loan market.
Linking the pricing of all loans to an external benchmark as the current Marginal Cost of Funds Based Lending Rate (MCLR) may not be comparable across banks.
What is Secondary Market for Corporate Loans?
The secondary market is the market where investors buy and sell securities they already own.
SLMA is a self-regulatory body and has been formed as per the recommendation of the Reserve Bank of India’s Task Force on the Development of secondary market for corporate loans
According to SLMA’s memorandum of association, it will facilitate, promote and set up an online system for the standardization and simplification of primary loan documentation, and standardization of documentation for the purchase and sale/assignment documentation and other trading mechanisms for the secondary loan market and its documentation.
The company’s website and logo were digitally launched on Wednesday by Saurav Sinha, Executive Director, Reserve Bank of India.
Benefits of Secondary Market for Corporate Loans
1. Better churning of funds
Currently, the secondary loan market in India is largely restricted to sale to asset reconstruction companies and ad hoc sale to other lenders including banks, but there is no formalized mechanism to deepen the market. So, options are limited and demand unknown.
- Developing the loan market will benefit banks because selling off existing loans will enable them to mobilize their funds better, thus enhancing the credit flow in the economy
2. Exposure/ALM management
The move will help banks realign their portfolio and balance asset liability mismatches (ALMs) along with improving profitability.
- Banks will be able to offload any excessive exposure to a particular company or a group. If they have long-term loans in the books, they can shorten the maturity by selling these long-term assets to other investors. This could be an alternative source to fund liabilities too. Besides, their return on assets and return on equity metrics will improve as they can improve their bottom-lines without increasing the asset base
3. Better price discovery
In case banks fail to judge the credit assessment of a corporate or potential of a project appropriately, and values the loan at lower or higher than the required interest rate, trading it in a secondary market may correct the loan pricing. "Market forces determining the pricing of loans will, of course, be more efficient. If the market deepens, better price discovery happens
Challenges to Secondary Market for Corporate Loans
1. Banks not doing due diligence
There could be a possibility that some of banks do not execute due diligence when originating the loan (being in a hurry to meet targets) knowing that they can sell it off later.
- The quality of due diligence by banks could be of different qualities. The way smaller banks show laxity in credit check in consortium-led lending, that may happen in the new set-up also because they know they can offload loans in the secondary market
2. Savings of common people could be at risk
Mutual funds, insurance companies and few other investors pool in savings of common people. They need to be careful about which corporate loans they buy in the secondary market as any default or delay in loan repayments may put their funds at risk.
- As evidenced by experience, the probability of default cannot be zero. Even the highest credit rating only signifies 'highest safety'. However, some of the more recent default events have triggered a review of the risk management systems including the role played by credit rating agencies. These checks and balances will continue to evolve and fine tune
