It is reported that market regulator Securities and Exchange Board of India is planning to make it mandatory for companies with over ₹100 crore debt and a credit rating of ‘AA and above’ to compulsorily raise 25 per cent of their debt from the bond market.
The move seems to be a premature one. Instead of allowing the market to function on its own, based on demand and supply, there seems to be an effort to arm-twist firms to go in for a particular type of financing.
In the bank-based system, banks play a dominant role in mobilising savings, allocating resources among the various sectors of the economy and regions of a country, and providing risk management facilities.
In a market-based system, the intermediary role of banks is reduced to a great extent and the investors or the savers directly park their funds with the borrowers (corporates).
Both the systems are prevalent in both developed and underdeveloped countries.
Market vs bank-based
According to a World Bank study, researchers have classified the world’s major economies where developed countries such as Japan, Germany, France and Italy and developing countries such as Argentina, China, India and Pakistan follow Bank based system.
Developed countries such as US, UK, Singapore and Korea and developing countries such as Brazil, Mexico and Turkey follow the market-based system.
Economists have found that financial systems tend to become more market-based as the economy develops.
Our system of saving and deployment of funds is a bank-based one. Our savers find it comfortable to lend the funds to banks and pass on the risk management to banks. For this transfer of risk management, they are willing to accept lower return on their funds. Forcing depositors to take the market risk will not work out. If the investors shun the equity or bond market, it is because of their risk aversion. Market participation has to mature on its own over a period and regulators can only provide conducive environment to facilitate that. Understanding this aspect, our banks are well regulated with CRR and SLR requirements to ensure safety of bank deposits.
In India people want assured return with minimum risk. How is this addressed by the bond market? How can the regulator check default by corporates? Given the highly leveraged state of corporates and the banks’ huge NPA problem, how can one expect corporates not to default on bonds on maturity or interest payment? Other than the listing on the stock market, how different are bond issues from company deposits?
Any default in interest payment by the company will make the bond price plummet in the market and there may not be buyers. When such an eventuality happens, how is the regulator going to ensure liquidity of the bond?
Banks undertake a proper appraisal before they lend.
But there is no such appraisal done by a bond investor and he will have to rely on other entities that are managing such issues.
Rating by approved rating agency is fine, but how do you hold a rating agency accountable if its recommendation goes awry?
The basic function of SEBI is to protect the interests of investors in securities market. Forced borrowing through bond market cannot be in the interest of the investors or corporates.
The writer is a retired banker