Designing the WLTF banks
The discussion paper by RBI on WLTF banks lists out certain key design elements for these institutions. RBI proposes an initial minimum capital of Rs 1000 crore which sounds reasonable given the nature of business. However, in the long term the capital maintenance requirement should be linked to percentage of the performing and non-performing assets. This would enable these banks to always have the requisite liquidity at all times. Many would agree that a key skill in lending to long gestation infrastructure and corporate loans is deep understanding of financial appraisal of these projects.
It should be ensured that the promoter group for WLTF banks is selected with strong focus on their capability to appraise long-term projects and associated challenges. RBI should also spell out eligibility criteria of projects that can be funded by WLTF banks. The criteria could be around sectors, nature of project like Greenfield vs. Brownfield and minimum tenor of say 10 years etc. RBIs proposal of relaxing Cash Reserve Ratio (CRR) maintenance and Priority Sector Lending norms for these banks is welcome, however, deposit insurance maintenance requirements should also be relaxed for these banks. Regulations around NPA and provisioning norms, security pledge of project equity and recovery processes should also be adapted keeping in mind the purpose of these banks.
There are two key critical areas that deserve attention to make WLTF banks a success. Firstly, identifying the right source of funds for WLTF banks would help define their business model. A key ingredient for WLTF banks would be its ability to raise cheaper long-term source of capital. The discussion paper proposes that these banks can raise current account and deposits above Rs 10 crore as one of the funding sources. This could prove to be counter-productive for the commercial banks. On one hand, commercial banks would lose lucrative lending business to WLTF banks and losing the current account and deposit business would only lead to financial hardship for the sector which is already being challenged by niche players like payment and small finance banks. In our zeal to create WLTF banks, we should not weaken the commercial banks and destabilize financial system, which are lifeblood for our economy. Instead the best-suited source of capital for WLTF banks would be insurance companies, pension funds, sovereign wealth funds, international capital markets and long-term bond markets. This would enable them to avoid the trap of asset liability mismatches.
To enable WLTF banks to raise funds from these markets, sovereign guarantee should be explored. For example, most of the European development financial institutions funding infrastructure and long-term projects benefit from government guarantees for enhancing credit worthiness. A suitable structure needs to be worked out for private participation such that proposed banks can avail the benefit of sovereign guarantee without overly depending on it.
Secondly, selecting the right promoter group for granting the license holds the key. The universal banking license criteria excludes large corporate houses. Assuming commercial banks are kept out of the promoter group, there would be very few players in the eligible promoter group which have the financial wherewithal and capability required for WLTF banks. Some of these institutions are already sponsors of Infrastructure Debt Funds (IDFs) and Infrastructure Finance Companies (IFCs), which have not performed as per expectation. It is also important to think how WLTF banks would be different from IDF and IFCs.
Project in Infrastructure, commercial and industrial sectors have a significant impact on the GDP growth and job creation in the economy. Setting up of specialized vehicles like WLTF banks would surely give a fillip to the overall economic activity, however it is very important that this initiative is implemented in the right way avoiding mistakes which traditional commercial banks have made funding long term projects. Detailed due diligence on the promoter group and appropriate financial structures for raising long term funds would go a long way to make WLTF banks a success.
Prof. Gourav Vallabh. Professor of Finance, XLRI, Jamshedpur and Mr. Suraj Chatrath, Management Professional and Stanford alumnus with global experience across banking, financial services and technology writes this piece for the July edition of Economy Watch.