A market for loans

Secondary market will need to cross many hurdles

Last week, a task force set up by the Reserve Bank of India to examine the possibilities of a secondary market for corporate loans in India submitted its report. The task force, which was led by Canara Bank Chairman T N Manoharan, suggested creating a self-regulatory body to manage the secondary market. This body would standardise the paperwork associated with loans, making them easier to trade; maintain the standards and examine documentation; maintain a central registry, and so on. Aside from the creation of this quasi-regulator, the committee also suggested that existing requirements be changed and the secondary market for corporate loans — currently dominated by banks — be thrown open to mutual funds, pension funds, and insurance companies. The market for stressed loans in India is, in fact, relatively diverse, given that banks are permitted to sell their stressed assets even to foreign investors via asset reconstruction companies, and that non-banking financial companies are participants in the process of securitising such stressed assets. However, it is not deep and is based mainly on arbitrary bilateral transactions. A more structured form of price discovery would be far more efficient — but worrying for banks, who would now be held to account by the market for their decisions on loan pricing. There are also tax implications for participants, which have to be worked out; the ministry of finance should direct tax officials to issue advance rulings where necessary.

The question to be asked is whether the constraint on market participation for secondary loans is purely one of regulation, or whether there is a deeper issue in making the market more liquid.

After all, while the recommendations of the Manoharan Committee are professional and forward-looking, the state of the corporate bond market — which, in most places, is more liquid than the secondary loan market — is disquieting, and suggests that there is simply not enough depth. For instance, Reserve Bank of India Deputy Governor B P Kanungo recently pointed out that “the secondary market in corporate debt is so illiquid that we can very well say there is no such market”. In the absence of sufficient liquidity, the market is not properly passing the price information about companies. As Mr Kanungo noted: The rating transition of some corporate debt, particularly those issued by financial firms, has been phenomenal — from sound credit to junk. The fact is, of course, that even the primary corporate debt market is stunted by the size of the market for government and quasi-government paper. And even that is dominated essentially by the 10-year benchmark G-sec. Investors regularly complain that there is such low liquidity in the secondary bond market that even top-rated bonds and government-financed infrastructure bonds being hawked on favourable terms often find no takers at all. While the regulators may be concerned about the development of offshore markets for derivatives, the fact is that greater innovation and regulatory cohesion are needed across the board for debt and loan markets. This must be priority for growing long-term finance and better pricing of debt — crucial to avoid investment crises such as those India is enduring.