Double Trouble

Indian Banks, Double Trouble

The problems faced by Indian Banks are on two fronts:

 Lack of demand: Slowing nominal growth, high real rates, and global uncertainties have
subdued credit growth
 Limitation of supply: Asset quality issues/provisioning have added to the woes by
constraining capital adequacy

Alternative funding sources exacerbating issues

The development of alternative funding sources, such as direct borrowing by corporates in the ECB
market or via issue of bonds, does solve (to an extent) the domestic liquidity crunch, but it does not
address the issues that banks face, i.e. competition in credit market has intensified, thus curtailing
profits and delaying an organic expansion of capital to moderate the NPL issues.

Solution needs to address flow of credit, and conduit of credit

The way to tackle this issue is to ensure that not only does increased credit flow through the system,
but, it flows though the conduit of banks and not directly.

My recommendation
Steps:

 Form three bank consortiums. The consortiums can be by way of SPVs instead of legal
mergers
 The consortiums should be formed like CDOs i.e., after considering risk profiles of the banks
in each consortium, and combining stronger balance sheets with weaker balance sheets,
credit profiles etc. in such a way that the overall of risk of the group is minimized
 Each of these three consortiums should issue 15 year maturity debt for say US$25bn (final
size can be decided later). While this is a significant number (5% of current external debt, 1%
of GDP, 6% of forex reserves), it is a number that as per some estimates will provide for 65%
NPL coverage, and a double digit credit growth. The consortium can distribute the bonds
among themselves as pre-agreed between them
 Designate these bonds as Tier I capital. This designation should stay for the first 8 years,
allowing banks to bolster their capital adequacy and power growth. These bonds can be
converted to tier II or even ordinary borrowings in a staggered manner over the balance life
of the instruments
 The bonds should be freely tradable. While they should be guaranteed by the Government
of India, the primary responsibility for paying them off at the end of 15 years will lie with the
banks. In fact since they will be trading, the Bank consortiums can take advantage of any
short term mispricing to retire some of the bonds early
 These bonds solve both issues, i.e. bolstering liquidity in the Indian economy, and doing it via
banks. The Tier 1 designation will ensure that bank’s capital constraints are loosened.

Anirudha V Limaye (anirudha14@gmail.com) – June 17, 2019 Page 1

 Double Trouble
 Long term investors, believers in the India story, pension funds, endowments etc. will be
prime candidates to buy this long dated security. Then exchange rate risk on these bonds
can either be fully hedged or dynamically managed by the Reserve Bank of India
 An attractive risk adjusted return on these bonds, will be a prime attraction for borrowers.
RBI too can participate with some of its forex reserves to take a position in these bonds as
well. It will be less politically inconvenient than asking RBI to pass on its reserves to the GoI
to fund deficit in any case

Anirudha V Limaye (anirudha14@gmail.com) – June 17, 2019 Page 2