Jury out on partial credit enhancements for NBFCs

To reduce the burden on banks for financing infrastructure projects, and to promote the use of the corporate bond market for this purpose, the Reserve Bank of India (RBI) permitted banks to provide partial credit enhancements (PCEs) to corporate bonds in 2015. PCEs were intended to enhance the credit rating of bonds, thereby encouraging long-term investors such as insurance funds and pension funds to invest in such bonds.

Following its September 2015 circular, banks were permitted to provide PCEs by way of non-funded subordinated contingent line of credit facilities, which could be drawn on in case of shortfalls in cash flows for servicing interest and principal payments on bonds supported by PCEs.

This PCE facility was limited to companies and special purpose vehicles funding infrastructure projects. The September 2015 circular expressly restricted banks from providing PCEs by way of guarantee, presumably so as to avoid a situation of the credit rating of the bonds “piggybacking” on the credit rating of the bank.

Sawant Singh and Aditya Bhargava are partners at the Mumbai office of Phoenix Legal.