Investment in corporate bonds could get a boost if the Reserve Bank of India’s discussion paper on prudential standards for bank investments is implemented. According to India Ratings and Research, the move would qualify corporate bonds to be included in the held-to-maturity (HTM) category of the investment portfolio, which would increase investment in these securities.
Investments in corporate bonds by banks in the HTM category will increase the investor base for these securities and help companies raise funds at better returns through a broader investor base. Over the years, pension funds and insurance companies have invested in long-term bonds, while mutual funds have remained investors in short- and medium-term bonds.
The proposed standards for banks’ investment portfolio will bring about structural changes that will allow banks to keep corporate bonds, or even shares of subsidiaries, associates and joint ventures, in the HTM category. Previously, banks were allowed to hold securities of central government, state governments and certain infrastructure companies in the HTM category, subject to 25% of the total investment.
The discussion paper categorized the investment portfolio into three main categories – HTM, available for sale and fair value through profit or loss. “Only debt securities with fixed or determinable payments and fixed maturity with the intention of holding them to maturity should be classified as HTM. Non-SLR securities such as corporate bonds that meet these criteria may therefore be allowed to be held in HTM,” the RBI said in a working paper.
The document states that the impairment test will be carried out on a quarterly basis, but India Ratings believes that certain rating restrictions via a minimum rating threshold are necessary to trigger the market release and subsequent alignment with the rate-based pricing. market.
The other challenge is that the HTM in corporate bonds will reduce the liquidity of those securities in the market, which will negatively impact market liquidity and the yields of those securities in the secondary market.
Banks’ trading books grew at a compound annual growth rate of nearly 11% between FY17 and FY21. Credit drawdown has been subdued since FY17, banks have found a balance between holding higher SLR securities and loans in a lower interest rate scenario, and face interest rate risk due to volatility in Treasury revenues, the rating agency said.