Restrictions on refinancing eased for select borrowers

By Sawant Singh and Aditya Bhargava, Phoenix Legal

In a move that few noticed, the Reserve Bank of India (RBI) in its statement on developmental and regulatory policies of December announced that overseas branches of Indian banks would soon be permitted to refinance external commercial borrowings (ECBs). Such refinancing would be limited to Indian bodies corporate rated “AAA” and public sector undertakings (PSUs) that are classified as “Navratna” and “Maharatna”.

Sawant SinghPartnerPhoenix Legal
Sawant Singh
Phoenix Legal

The Department of Public Enterprises’ Maharatna PSU classification is limited to fewer than 10 entities, and includes Coal India, Indian Oil Corporation, Oil and Natural Gas Corporation, and Steel Authority of India. The Navratna PSU classification is limited to fewer than 20 entities and includes Oil India, Power Grid Corporation of India, Hindustan Petroleum Corporation, and Hindustan Aeronautics. These entities are prominently associated with the Indian economy and are often considered to be a “safe credit” due to a purported implicit sovereign guarantee.

By way of brief background, until the recasting of the RBI’s prescriptions on ECBs by Indian borrowers circa November 2015, overseas branches of Indian banks were not specifically prohibited from refinancing ECBs. The revised ECB framework contained a provision that specifically omitted overseas branches of Indian banks as “eligible lenders” for the purposes of refinancing ECBs.

While no explicit rationale for this was provided, this may have been done with a view to clamp down on the possibility of “hot capital” – funds raised overseas at a much lower cost of funds – being channelled to Indian borrowers. Indian regulators have always frowned on such hot capital because of the risk posed to macroeconomic stability through overheating because of easy (and cheap) credit. Another factor that may have been considered is that most Indian banks that have overseas branches are also substantially (if not majority) owned by the Indian government, and therefore carry the suggestion of an implicit sovereign guarantee. This could be a potential source of reputational damage if a stressed Indian borrower whose ECBs had been refinanced by such overseas branches became insolvent.

Aditya BhargavaPartnerPhoenix Legal
Aditya Bhargava
Phoenix Legal

In any event, the blanket restriction on overseas branches of Indian banks refinancing ECBs led to a “throw the baby out with the bath water” situation, where even highly rated borrowers with excellent credit history were unable to tap such overseas branches for refinancing their ECBs at a lower rate. It is common for domestic borrowers to have a strong preference to borrow from overseas branches of their existing lenders in India or from a lending syndicate led by such an overseas branch.

The restriction had the unintended consequence of business being generated for overseas banks at the expense of Indian banks, particularly in respect of borrowers that are considered low risk and are therefore reckoned as prize credit assets for banks. The uptick (albeit minor) in lending rates due to the credit supply asymmetry caused by the restriction also created an anomalous incongruity in lending rates for Indian borrowers and similarly placed borrowers from other jurisdictions. From an economic perspective, Indian borrowers were left vulnerable and more exposed to global financial tremors that could dry up lines of credit from overseas lenders, a consequence that may have a lower probability of occurring if other Indian lenders are also able to lend.

The RBI in its December statement notes that not allowing overseas branches of Indian branches to refinance ECBs leads to an uneven playing field, and resolves to rectify this by issuing revised directions. The RBI welcomed 2018 with a notification on 4 January reflecting the statement.

The notification allows overseas branches of Indian banks to refinance ECBs at a lower “all-in-cost” and subject to the maturity of the ECB not being reduced. This is in line with conditions applicable to refinancing of ECBs generally. The notification also contemplates partial refinancing of an ECB by an overseas branch of an Indian bank on similar terms. As a “fail-safe” in light of the economic and other risks mentioned above, the borrowers whose ECBs can be refinanced are limited to Maharatna and Navrata PSUs and “AAA” rated bodies corporate.

The December statement and the notification reflect the proactive approach of the RBI and its openness to feedback on regulations from stakeholders. However, given that the drawbacks of a particular approach are ascertainable and it can be predicted that tweaks to a regulation will be required, it might be useful to have a formal cost-benefit analysis mechanism for each regulation before it is implemented.

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


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