RBI allows credit enhancement limited to 20% of individual bond issue size

MUMBAI: Banks can offer partial support to corporates floating bonds to raise debt capital to meet long-term project funding needs, as the RBI has allowed partial credit enhancement of up to 20% of the individual bond issue size. The credit line can be used when any bond issuer faces cash shortage during construction work, or when it is struggling to repay debt, or its projects are running into trouble.

“The objective behind allowing banks to extend partial credit enhancement is to enhance the credit rating of bonds issued so as to allow corporates to access funds from the bond market on better terms,” the RBI said on Thursday. “The partial credit enhancement ( PCE) facility shall be provided at the time of bond issue and will be irrevocable.”

Banks can extend such a credit line only in respect of bonds whose pre-enhanced rating is BBB minus, the lowest investment grade, or better, but they cannot provide PCE as a guarantee. Banks providing PCE to bonds are barred from investing in them. “They can, however, provide other need-based credit facilities (funded and/or non-funded) to the corporate/SPV,” the RBI said.

This, in turn, should add confidence to insurers, pension or provident funds, all long-term investors, which are normally hesitant to invest in lower-rated corporate bonds rated below AA+ or so. Unlike banks, which face challenges to fund long-term projects, pension or provident or insurers can bet on long-term corporate bonds with 10-15-20 year maturities.

The regulatory requirement for insurance and provident/pension funds is to invest in bonds of high or relatively high credit rating. “Bonds issued for funding projects by corporates/SPVs do not necessarily get high ratings from credit rating agencies because of the inherent risk in the initial stages of project implementation,” the RBI said. The central bank has also mandated certain methodologies for balance sheet treatment.

PCE facilities to the extent drawn should be treated as loan in the balance sheet. Undrawn facilities would be an off-balance sheet item and to be reported under ‘Contingent Liability – Others’, RBI said.