Relative Advantages of Raising Finance in Domestic & Offshore Markets

Last week three highly experienced new-breed bankers addressed our Club: Madan Menon on ’‘Offshore Debt and equity-linked markets’, Atul Sud on ‘Domestic Capital Markets’, and Gautam Vir on ‘Niche banking’ .

Madan Menon, Managing Director of The Royal Bank of Scotland, started his career at The American Express Bank. Atul Sud started his career in the American Express Bank and later set up his own company Strategic Capital Corporation in 1992-93, which is a NBFC. Gautam Vir started off with Citibank, then went to Standard Chartered Bank and worked in countries like Oman and Bulgaria. He now heads the Development Credit Bank.

Madan Menon on Offshore Debt and equity-linked markets:

“The offshore loan markets comprise three main strata:

• The syndicated loan markets, which comprise of primarily foreign banks based offshore in Singapore and the rest of Asia.
  
  
• The domestic and the offshore capital markets,which include the debt markets constituting institutional investors such as pension funds and asset managers.
  
  
• Equity linked markets, which comprise of the same community of buyers.

“In many ways, in the last 7 to 10 years, these markets have supported India’s growth, particularly in the corporate sector and most recently in the banking sector. How have these markets assisted India in its progress towards becoming, as the McKinseys says, the dominant economy by 2050?

“Earlier, the financing needs of corporates were met by local banks. That trend has changed over the past decade with some large corporates leading the way into the offshore debt markets. As opposed to borrowing locally in Indian rupees, you now have the option to selectively borrow in the offshore markets.

“Why tap offshore as opposed to onshore for finance? There are many reasons:

“Firstly, cost-effectiveness. In the past, the interest rates in India were significantly higher than they were offshore. Today that gap has reduced, but it is still advantageous to borrow in offshore markets. In 2006, Indian corporates and banks raised $ 7 billion from the international markets. In the first quarter of 2007 alone, more than half that amount has been sourced in the offshore markets.

“One also witnesses local banks and financial institutions that seek their funding needs in the offshore markets for size, tenure and volume as opposed to what they borrow locally. In the last two years domestic Indian banks and FIIs have borrowed far more in the offshore markets than what they have done in the last ten years. This impacts you and me because they borrow cheap in the offshore markets, and are able to extend cheaper loans to you and me or to the corporate sector.

“Secondly, volumes. Huge volumes are available in the offshore markets. A $100 million transaction in the Indian context is certainly viewed as being large; but $500 million in the offshore markets is not considered large.

“Thirdly, they don’t ask for security. Typically, for you and me or for a company to borrow domestically, we need to provide some element of security, whether it is your home, your television set or in the case of a company, some machinery. That security is not required in the offshore markets. You borrow on an unsecured basis.

“Another reason is the tenure of the loan. Domestically you can probably go in for three or five years or upto 10 or 15 years in case of housing loans. In the offshore market, we can get loans for upto 30 or 40 years, and in some cases 100 years, as Reliance has done in the recent the past.

“What do corporates use this funding for?

“Acquire companies in the offshore markets. Recent examples are the Tata Corus transaction, Ranbaxy’s and Dr Reddy’s Laboratories and multiple companies.

“For expansion. You borrow in the offshore market at a cheaper cost and use it to reduce the cost of your project.

“The largest change, apart from volume and the acceptability in India in the international loan markets has been in the terms of who uses these tools. Five to seven years ago, maybe Reliance, or Exim or IDBI or the State Bank of India, borrowed extensively in the offshore markets.

“That is no longer the case. The largest users in terms of the number of users in the offshore markets is the so-called midcap community today, who enjoy dominance in their business, have robust plans and are seeking the official use of funding today.

“In the past two years, RBI has enabled the banks and FIIs to go abroad and borrow in significant volume, size, scale and tenure for mainly for financing the midcap community in the last two years.

“From an investor’s standpoint, offshore loan markets remain robust, price tension is good, complexity is there and that market will continue to dominate, if not grow to a size and scale where it collaborate with the onshore markets,” concluded Madan Menon.

Atul Sud on Domestic Capital Markets:

“When one refers to the term ‘capital markets’, people in India generally think of the share bazaar.

“Money comes into the country from three places in the organized commercial sector:

• Banks and bank deposits in India
  
  
• Money invested in post office accounts around the country.
  
  
• Money invested in insurance and provident fund.

“LIC itself is a ten lakh crore company. Between LIC and private insurance companies, they are 40- 50% the size of bank deposits.

“Provident funds are created out of our monthly salary deductions. So if you add the provident fund and the insurance money, that is almost half as much as what is in the banks.

“Where does all this money go? It doesn’t go into the share market, which mainly gets money from people like us who individually buy shares, or put it in mutual funds, or foreigners who come and put in money from abroad.

“In India, we have a history of Nehruvian socialism where the government decides everything we do. So the government tells the insurance companies, for example through IRDA, that 80% of the money they collect must be put into government securities, state government securities and municipal corporations — which as we know is wasted and given away in various form of unproductive expenditure for implementing populist schemes.

“They are disallowed by law from investing more than 10-15 % of the huge provident fund and insurance money in the private sector, which uses the money far more efficiently.

“Why not let them buy bonds or loans of private sector companies? Many don’t know that the 10% of provident fund money that is permissible to be invested in private sector, can only be invested in highly rated companies like Reliance and Mahindra’s.

“So five to ten crore good small companies are deprived of a source of cheap money, cheaper interest rates, higher profitability and faster growth.

“On one hand, RBI says that if a bank needs to be solvent, it should keep Rs 10 as capital for every Rs 100 of deposits, and after that, lends money to anyone who needs it. On the other hand, the government disallows provident funds or insurance companies from doing that.

“The largest source of savings in the country is provident funds and insurance, because that is meant to be used either when you retire or by your beneficiaries when somebody dies as in the case of life insurance. That means these savings are for at least 25 or 30 years. This is the best money if you want to build bridges and ports and power plants and airports, because these have long gestations periods.

“If, instead of getting 10-year housing loans, if you could get 25- 30 year housing loans, your EMIs would go down by two-thirds. So you would borrow more, build bigger houses, have cheaper interest costs.

“Take it from me, this situation does not prevail in developed countries.

“One can have a simple system to ensure that the insurance companies do not fail or make losses. There should be a diversified pool for investment, so that an insurance company would not invest more than 2% of its funds in one company.

“Why should only the public companies get money? Why not private companies? Why must the insurance and provident fund only invest in highly rated bonds like AA+ rather than in smaller companies with lower rating? If they invest in a smaller company with a lower rating, then they will get higher returns, your insurance policy holder will get a higher bonus, and provident fund contributors will get higher return.

“The net result of all this is that we have a high interest rates in India. Indian interest rates for ten years for example are 8 % for government borrowing, whereas dollar rates are 4-5 %.

“In the share market, we have a futures and options market where one can hedge the price of your share that you are worried about due to several reasons, you can hedge the market by looking at the forward market. There is no forward market in bonds, so people are scared to buy in case yields go up or down. The public at large invests in shares. In India only banks and insurance companies invest in bonds, because the RBI does not allow them to invest in the debt markets, except in AA+ for more than 10%.

“Insurance companies are not allowed to buy securitized housing loans. So LIC can’t buy the housing loans that people take. Brokers in the share markets get finance from banks and intermediaries in the debt markets get no finance. As a result we have a debt market which has a narrow investor base, no brokers and no financing.

“Our GDP growth of 8% is coming from foreign money; and all the Barclays and Royal Banks and all the convertible issues are getting money. So we are exporting our debt markets abroad by overregulating them. We are not allowing Indian money to be lent to Indian borrowers and we are giving jobs and returns to people abroad, who make money when the Sensex goes from 3,000 to 14,000 points.

“I am not saying that this should not be allowed, but we can make our own country more efficient by opening up the debt markets, as we have opened up the equity markets,” Atul Sud concluded.

Gautam Vir on Niche Banking:

“Is there a lot of competition in the banking business or not? I would say ‘yes and no’. India is an economy growing at 8-9% and the banking business, as a result, grows at a 30 %.

“This is an indication that there is a huge market and opportunities up there in the banking field. In your businesses, a 30% growthis very substantial. The core commercial banking business involves mobilization of deposits and extension of loans to individuals, small and large organizations in the country.

“About 70% of the banking business in India is controlled by the nationalized sector and that does not offer scope for much competition. That’s what provides the opportunity. If you are well focussed on your target markets, then there is no reason why you cannot have extensive and significant growth.

“Our organization is not a Pan India institution. We don’t want to be one, nor do we aspire to be one. We build and operate in the western India corridor, where we believe there are huge opportunities.

“Take Gujarat for instance. As an economy, in terms of population, in terms of economy, industrial production, it is bigger than most countries in the world. The state offers an opportunity to do business on a standalone basis.

“People operate in countries that are as big as one Indian state. So you don’t have to be national to be huge, you can be in a niche position by handling something purely regional. Whom do you service? Do you service all elements, parts and niches of the business? It is upto you. You could be competing with large players, or smaller ones.

“By focusing on segments, you could be focussing on medium or large scale organizations or traders. Within the individual segments, you could be dealing with the mass markets or the high networth individuals. Some segments are more profitable and some others are less.

“India has a population of 1.1 billion people. About 600 million people do not have excess to full fledged banking facilities — an opportunity for bankers. RBI is pushing banks to go into underbanked areas and providing an opportunity to do so. Each of these can be seen as either a problem or an opportunity around which you can build your businesses.

“One lesson to learned here is that every financial instituition has to be clear onwhat it wants to achieve, and it has to set up processes to meet these objectives. “International banks in India have basically segmented their businesses. They have an individuals segment, one for the high net individual, a different segment each for small and large corporate and they operate with a very centralized back office to help support that.

“Nationalized banks within the country have a very decentralized processing environment with geographic orientation. They have regions and bank managers who are empowered to do various things.

“We as an instituition are finding that to provide a service that customers are looking for, the best thing is to have a combination of both: some things that are centralized and some decentralized.

“Some of the niche opportunities arising from the policies direct us towards financial inclusions, to ensure that the people will get access to real credit. There are about 200 million households in India, of which 90 million are in the rural segment, with marginal farmers. Another 30 million represent microenterprises which have lending opportunitiesof Rs 120,000 crore — a significant amount of money, which, if the banks play their cards correctly, they can get themselves involved in. There is a huge opportunity for financial institutions to participate in, along with NGOs and organizations like the Rotary, in a bid to eliminate poverty. In this sector, there is a huge opportunity for banks to grow at faster pace than the current 30-40%,” concluded Gautam Vir.