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India has taken steps to clamp down on the growing trend among banks to convert rupee exposure into overseas debt in a move likely to trigger a rise in onshore restructurings.
In a notice issued on Tuesday evening, the Reserve Bank of India warned that Indian banks should not lend through their overseas branches or issue any kind of credit guarantee to help companies repay their rupee obligations with offshore debt.
The notice comes as the RBI is forcing banks to deal with stressed loans by restricting the practice of "evergreening", a common term for refinancing, rather than restructuring non-performing loans.
"The amount of non-performing loans in the Indian banking system is grossly understated due to 'greening' of loans," said Sanjay Guglani, CIO of Singapore-based Silverdale Capital. "The RBI notification is a step in right direction to curb the misuse of offshore borrowing by Indian corporates to service rupee obligations."
The RBI recently introduced tougher reporting standards to curb the practice onshore by forcing banks to recognise non-performing loans sooner. At the same time, however, Indian banks have been transferring more rupee assets into the overseas markets, either financing them directly or writing guarantees.
"Banks are extending non-fund-based credit facilities like guarantees/standby letters of credit/letters of comfort, etc, on behalf of joint ventures/ wholly owned subsidiaries/ wholly owned step-down subsidiaries to avail foreign currency loans for repayment of rupee loans," the RBI said in its April 22 notification.
The notice also bars banks from writing overseas standby letters of credit or other forms of credit support for "the purpose of raising loans/advances of any kind from other entities except in connection with the ordinary course of overseas business." It also requires banks to monitor the end use of proceeds to ensure they are not misused.
The move aims to improve transparency and prevent a build-up of risks within the Indian banking system, but analysts also warn it could leave more companies facing funding squeezes.
Standby letters of credit had helped companies, such as Suzlon Energy, access the international capital markets when it was in the middle of a debt restructuring, and the format allowed Indian lenders to recycle capital by converting a funded liability into a non-funded exposure.
"These structures evolved as they reduced the funding costs for stressed corporates and eased the balance sheets of banks," said a Singapore-based lawyer.
As banks will now be more cautious in providing contingent liabilities, companies will be forced to accept restructurings and this, analysts say, will add to the pace of non-performing assets in the system.
"The RBI notification has spoiled the sentiment towards non-fund based facilities. Banks will definitely shy away from these facilities," said a Mumbai-based loan banker.
Indian rules do not allow refinancing of rupee loans with foreign debt. However, in June 2012, manufacturing and infrastructure companies were granted an exemption as onshore interest rates spiked.
The fact that domestic Indian banks are backing new offshore loans, however, seems to have raised a red flag for the regulator, and the notice sends a clear sign that offshore refinancing will only be allowed if it does not involve additional liabilities for Indian banks.
"If the [external commercial borrowing] is availed from overseas branches/subsidiaries of Indian banks, the risk remains within the Indian banking system. It has, therefore, been decided that repayment of rupee loans . through ECBs extended by overseas branches/subsidiaries of Indian banks will, henceforth, not be permitted," the notice said.
Market participants expect the RBI's move to have an impact on several financings in the market that feature standby letters of credit from Indian lenders.
Lanco Infratech, which is in the process of restructuring its rupee debt, recently launched a US$200m dual-tranche loan that comes with a guarantee from ICICI Bank. The loan, which Credit Suisse prefunded, partly refinances an acquisition loan in Australia, which the Indian lender arranged for Lanco in 2012.
Participation of banks in the US$250m two-year loan for Drilling & Offshore, part of Mumbai-listed ABG Shipyard, may also be impacted. The Deutsche Bank-run facility is backed with refund guarantees from Bank of Baroda, Bank of India, Export-Import Bank of India, ICICI Bank, IDBI Bank, Punjab National Bank and State Bank of India.
Aban Offshore, India's largest offshore drilling contractor in the private sector, recently signed around US$2bn of 15-year facilities backed by standby letters of credit.