The Reserve Bank of India (RBI), lead by the panel headed by T.N. Manoharan, has proposed a number of recommendations aimed at the development of the secondary market for corporate loans within the country. This set of suggestions includes a strategic mix of inclusive participation, transparency via online platforms, a standardized approach as well as a self-regulatory body.
Key Suggestions from the RBI-Headed Panel
The panel has suggested setting up a Self-Regulatory Body (SRB) of participants to finalize the details for the secondary market for corporate loans, and standardize the related documents. Additionally, it has recommended the creation of a Loan Contract Registry which will work towards removing information asymmetries between buyers and sellers.
Another stand-out proposal is the launch of an online loan sales platform that will conduct auctions and sales of loans. The idea behind this is to leverage the potential of digital technology in enhancing the efficiency and speed of transactions.
Participants of the Corporate Loan Markets
The panel’s report advocates for the broadening of the spectrum and the inclusion of non-banking entities such as mutual funds, insurance companies, and pension funds as participants in the loan markets. As it stands, Banks and Non-Banking Financial Companies (NBFCs) are currently the only participants in the primary and secondary loan markets.
In addition to this, the panel suggests that single loan securitization should be considered as a way to incentivize investors to acquire loans through the secondary market mechanism. Currently, securitization is only permitted for a pool of homogeneous assets.
About Securitization
Securitization is a process by which a company brings together its different financial assets/debts to form a consolidated financial instrument which is issued to investors. In return, the investors in such securities receive interest.
Role of Foreign Portfolio Investors (FPIs)
The panel further advocates for allowing Foreign Portfolio Investors (FPIs) to directly purchase distressed loans from banks. At the moment, FPIs have to go through the Asset Reconstruction Companies (ARCs) to participate in the distressed loan market.
Loan Pricing Mechanism
Lastly, the panel advises 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.
Understanding Asset Reconstruction Companies (ARCs)
An Asset Reconstruction Company (ARC) is a specialized financial institution that buys bank debtors at a mutually-agreed value and attempts to recover the debts or associated securities by itself. ARCs are registered under the RBI and regulated under the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 (SARFAESI Act, 2002). Such companies primarily takeover parts of the bank’s debts qualified to be recognized as Non-Performing Assets.
| Panel Head | Suggestions |
|---|---|
| T.N. Manoharan | Self-regulatory body, Loan Contract Registry, Online loan Sales Platform, Inclusion of non-banking entities in loan markets, Single loan securitization, Direct participation of FPIs in distressed loan market, External benchmark for loan pricing |
Significance of a Secondary Market for Corporate Loans
The secondary loan market in India is largely limited to the sale of loans to Asset Reconstruction Companies, due to a lack of a formalised mechanism to deepen the market. The existence of a vibrant, deep, and liquid secondary market for debt can significantly enhance the efficiencies of the debt market, thus aiding in the resolution of stressed assets. It can also greatly help in transparent price discovery of inherent riskiness of the debt being traded. Consequently, the secondary market for loans can also be an essential mechanism for credit intermediaries to manage credit risk and liquidity risk on their balance-sheets, especially for distressed assets.