How RBI plans to equip banks for infrastructure financing

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Infrastructure is set to be one of the main focus areas of the Narendra Modi-led National Democratic Alliance (NDA) government. Finance minister Arun Jaitley’s maiden budget on 10 July may set the set the ball rolling.

Meanwhile, the Reserve Bank of India (RBI), I am told, is giving final touches to a set of new norms that will enable commercial banks to generate long-term resources to support infrastructure projects. This is being done by allowing banks to float long-term bonds. Such bonds can have as long a tenure as 20 years. The norms are likely to be released after the budget.

With implicit government guarantee, such bonds can offer slightly higher interest rates than government bonds and hence there won’t be any dearth of takers. Sold well, they will generate long-term liquidity for banks.

Now comes the interesting part. These bonds will be exempted from the requirements of cash reserve ratio (CRR) and statutory liquidity ratio (SLR). CRR refers to the portion of deposits that banks need to keep with RBI on which they don’t earn any interest and SLR is their compulsory bond holding. Currently, CRR is pegged at 4% of a bank’s deposits and a bank needs to invest at least 22.5% of deposits in government bonds.

By exempting such bonds from the regulatory pre-emptions, RBI will make life easy for banks as their cost of funds will be reduced.

On top of that, since infrastructure sector is considered a priority, RBI will exempt money borrowed through such long-term bonds from the so-called priority sector lending norms. Does this sound like a riddle? Well, under the priority loan norms, banks need to give loans to agriculture, small-scale industries and economically weaker section of people to the extent of 40% of their loan book. Eighteen per cent of such loans must be disbursed to the agriculture sector. Because these are typically small-ticket loans, the transaction cost is high. Banks do not earn much on such loans and many of them struggle to meet the target. Particularly, foreign banks and private banks find it difficult. They give loans to microfinance institutions (MFIs) who, in turn, lend to poor rural borrowers. Loans given to MFIs by banks are treated as part of priority loans.

The SLR requirement is high in India as the government needs to borrow a hefty amount from the market to bridge the fiscal deficit. Exempting the long-term funds, dedicated to infrastructure financing, from this indeed is a welcome step.

While the idea of long-term bonds floatation by banks to generate resources that could finance infrastructure projects is good, by exempting such funds from the priority loan norms, RBI is admitting that priority sector loan is a burden on the banking system. It is high time that the banking regulator looked into the priority loan norms and redefine priorities for banks.

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