India has a huge unmet need for infrastructure investment, which the government has estimated at around Rs43 trillion ($660 billion) over the next five years. Close to 70% of this amount should go to power, roads and urban infrastructure.
But where will the money come from?
Globally, infrastructure is typically financed by institutional investors after matching long-term liabilities and risk-return expectation. In India, however, infrastructure investment is mostly undertaken by public sector banks, which issue long-term funding to infrastructure projects on the back of deposits that are short-term in nature. This has led to asset/liability mismatch risks for Indian banks.
Infrastructure accounts for almost 15% of total non-food credit extended by the Indian banks. In value terms, infrastructure lending has more than doubled from $63 billion in 2010 to $140 billion in 2014, but in percentage terms it has been flat.
Indian public sector banks are bogged down by bad loans and weak profitability, and are reaching their exposure limits in infrastructure lending. Last year, these banks—which own 70% of the assets in the sector—had accumulated nearly 88% of non-performing assets.
Compounding the banking sector’s problems are the new Basel III norms, which are intended to strengthen bank capital requirements and will be fully implemented by 2019.
Since infrastructure assets are typically funded with a 70:30 debt to equity ratio, the total estimated equity investment is close to $200 billion and with the remaining balance of $460 billion as long-term debt. These huge needs for long-term debt are a loud call for India to tap alternative funding sources, like through securitization of infrastructure assets.
Securitization can fill infrastructure investment gap
Securitization allows a lender to sell a pool of assets on which bond market securities are issued. This—especially if undertaken through the sale of pass-through securities—frees up and potentially recycles capital.
Securitization thus facilitates access to bond market participants such as insurance, pension, and mutual funds.
Turning assets into securities can help release funds for Indian public sector banks by converting their illiquid infrastructure assets into marketable securities that they can sell to institutional investors. Securitization also strengthens banks’ capital position, and makes infrastructure financing more accessible to institutional investors.
India has a large pool of national savings, in excess of 30% of GDP, including through contractual savings institutions like pension and insurance funds who may have an appetite for securitized assets which can match their long-dated liabilities.
Since the country’s securitization market is still in a nascent stage, several challenges need to be addressed to catalyze investor demand for securitized infrastructure assets in India. These include appropriate selection of asset pools, mechanisms to manage the floating-to-fixed interest rate risk of infrastructure assets, as well as institutional and monitoring mechanisms.
The typical ratings of infrastructure bonds in India are often too low for these institutional investors, which currently invest in securities with a minimum domestic credit rating of AA. As such, support through credit enhancements can help meet the return requirements of these investors.
ADB is providing technical assistance to help the Government of India explore the potential of securitization. Taking this approach would help public sector banks release funds to alleviate their capital constraints, expand institutional investors’ access to risk-adjusted quality financial assets, and unlock enormous funding potential to help meet the country’s infrastructure needs.