Why the rollout of the secondary loan market is good news for everyone

With Axis Bank aligned With 1,000 crore loans for sale on the Secondary Loan Market Association platform later this month, the Indian financial market is taking another step towards greater transparency and efficiency.

The market for bank loans is different from a market for corporate bonds or securitized assets. Loans are not, cannot be, as standardized as bonds and must be purchased in large chunks, in proportion to the total loan in each case; nor is the platform on which the loans would be traded a securities market regulated by market regulator Sebi. The regulator is the Reserve Bank of India (RBI), the regulator of banks, above a self-regulatory body. The market participants would be banks on the sell side and banks of different sizes, non-banking financial companies, insurance companies, pension funds and mutual funds on the buy side, except corporations asset rebuilders, who already buy bank loans when they go bad.

A bank grants a loan to a borrower on the basis of a relationship and based on its own understanding of the viability of the project for which the loan is raised. The loan may be subject to specific binding conditions for the lender or the borrower or both. For relatively short periods (tenor, in the jargon) and relatively small amounts, loans are fine. When the loan amount is large and the term is long enough to create an asset-liability mismatch for the bank, it makes sense for the lending bank to sell the loan to willing buyers and create cash. Personal loans, for example residential mortgages, are regularly securitized and sold, but corporate loans are generally illiquid. This is about to change.

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There would be multiple benefits. Chief among them is the external assessment of loan pricing. Too comfortable a relationship between the lending bank and the borrower could lead to an unrealistic cost of credit, i.e. the relevant risk factors might not be fully taken into account. This could be for very valid reasons, such as trust, born from past experience of the borrower’s entrepreneurial success. Or it could be for less valid reasons, such as non-commercial persuasive factors behind the loan sanction. If the loan is sold in a secondary market, different sets of eyes would value the loan and arm’s length pricing would emerge. The variation of this price with the price obtained by the original lender would tell its own story. This price would make it possible to better price future loans.

Pricing information from loan market functioning and repayment history would allow realistic credit default swaps, which insure credit against default, to emerge. This, in turn, would help crystallize a market for corporate bonds.

India is a fast-growing emerging market that needs to build much of the infrastructure that would be needed to enable and sustain growth to ensure prosperity for its giant population. That would require a lot, a lot of debt. Ideally, large infrastructure projects should be financed by long-term bonds, purchased by insurance companies and pension funds that need long-term deployment of the funds entrusted to them. Bonds disperse the risk of default in society. Without a functioning corporate bond market, the risk of critical infrastructure projects would be concentrated in the hands of the banks lending to those projects. A secondary loan market is useful, both in helping to form the preconditions for a deep market for corporate bonds and in helping to disperse the risk of a loan more widely than between depositors, shareholders and the providers of capital absorbing the losses of the lending bank. pads.

A secondary market for business loans allows small banks and non-bank financial companies, in addition to asset managers who take on long-term liabilities such as insurance and retirement, to participate in a juicy credit opportunity . Original lenders have the ability to dilute their exposure and credit risk.

Borrowers, whose credit is sold by the original lender, also benefit. Their lender base is expanding, making it easier to access additional credit, to the point that they could even refinance their existing loans on better terms.

It has taken three years since an RBI task force recommended the establishment of such a bank loan market for it to start functioning. Better late than never.

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Priscilla C. Carnegie