India's first national Budget under PM Narendra Modi's reform-minded government is likely to include measures making it easier for banks to access long-term funding, according to sources close to the situation.
A growing asset-liability mismatch in the Indian banking system and the need to ensure a steady flow of long-term capital for the infrastructure sector have pushed officials to consider reforms to the use of senior bonds as a bank funding tool, the people said.
Details of the measures are still under negotiation ahead of the July 10 Union Budget statement, but the discussions ongoing within the finance ministry underline the new government's determination to address the failings of India's banking system.
India's mostly state-owned lenders have shied away from issuing senior bonds in the local market simply because the Banking Regulation Act of 1949 does not explicitly allow banks to do so. Some banks have circumvented the rules by issuing senior debt overseas, but most lenders remain heavily reliant on deposits and short-term funding.
Almost half of all bank funding in the country matures in one year or less, according to analysts, while nearly 80% of the Indian banking sector's funding is held in deposits.
At the same time, Indian banks are heavily exposed to the infrastructure sector, typically through long-term loans. As of April this year, Indian bank lending to the infrastructure sector stood at Rs8.4trn, up 11% year-on-year and nearly 15% of all Indian credit.
Such a mismatch in maturities raises the risk of a systemic crisis should short-term funding markets seize up, as proved to be the case in the US in 2008.
It also complicates efforts to raise long-term funding for sorely needed infrastructure projects, and leaves developers exposed to varying interest charges that can have a big impact on running costs.
"Banks keep annual resets on project and corporate loans so that they can align their short-term funding costs with long-term liabilities," said a DCM banker. "Banks generally avoid raising long-term money at market rates."
Senior bonds are an established source of bank funding worldwide, and the potential for an Indian market is huge. Assuming restrictions are lifted, market participants believe Indian banks could issue at least Rs500bn-Rs600bn (US$8bn-$10bn) of senior bonds in the first year at tenors mainly of 10 to 30 years.
The government is expected to take a flexible approach to allowing senior bank bonds given the failure of a similar attempt in the past.
In June 2004, the Reserve Bank