| Following the RBI directive, banks in India have finally dumped the prime lending rate (PLR) concept and ushered in a new regime called benchmark prime lending rate (BPLR) in the new year. |
| The difference is a small but vital one. Although banks were declaring their PLRs, some of their loans "" especially home loans "" were not linked to this rate and were, therefore, tough to track. RBI's insistence on one BPLR for all loans, irrespective of their profile or maturity, is designed to introduce transparency in the system. |
| The downward movement in rates varies between 25 and 50 basis points, depending on the bank. This is at a time when interest rates globally are showing signs of firming up and all market-related rates in India have reached a plateau. |
| The State Bank of India (SBI) has fixed its BPLR at 10.25 per cent, 25 basis points below its existing PLR. Both Punjab National Bank and Union Bank of India have cut their PLRs by an identical margin and fixed their BPLR at 10.75 per cent. Kolkata-based Allahabad Bank's BPLR is on the higher side at 11 per cent but it's still 50 basis points below its PLR. Ditto for Central Bank of India. |
| The BPLR system has been put in place in response to the RBI's April 2003 credit policy that hinted at creating a new benchmark for lending rates, taking into account banks' actual cost of funds, operating expenses, a minimum margin to cover regulatory requirements of provisioning on account of non-performing assets, capital charge and profit margin. |
| The RBI had had rounds of discussions with banks on this, but failed to convince them because they insisted that they were already following the process while fixing the PLR. So, the Indian Banks' Association (IBA) was roped in to work out a formula. Finally, a series of announcements was made by the banks around Christmas, lowering the rates from the new year. |
| There could be three explanations for this trend. |
| First, the RBI might have arm-twisted banks to drop the rates because a large section of borrowers is still deprived of the low rate regime. This, however, is unlikely to be true because the central bank cannot afford to do this in an era of deregulation. |
| Second, banks have never had any risk-management system in place and the asset-liability committees of most banks existed only on paper. In other words, they have never done their cost analysis to fix their lending rates. Traditionally, they have been following leaders like SBI and ICICI Bank to fix lending rates. |
| Once the lending rate is fixed, they take a close look at their deposit rates and fine-tune them to keep the spread (the margin between cost of funds and interest income) intact. Essentially, they fix the cost of assets first and then adjust the cost of their liabilities. This could be a radical observation but true for at least some of the banks. |
| Third "" and this is the most plausible explanation "" banks have found the easiest way of paring their lending rates. This is done by simultaneously cutting deposit rates. This way, the benefits that they are passing on from one window are being taken away from another. Depositors are being penalised to make borrowers happy. |
| This, however, is not a new trend. Over the past two years, the average rate offered by banks over a one-year deposit has dropped by about 275 basis points (from 7.5 to 8.5 per cent in March 2002 to 5 to 5.75 per cent in December 2003). The fall in PLR during the period was only about 100 basis points (from 11 to 12 per cent to 10.5 to 11 per cent) in the same time frame. |
| But one cannot blame banks for being so uncharitable to depositors because they are under pressure to dole out money at government-determined rates in various sectors. The pressure will intensify with general elections around the corner. A command economy is slowly creeping in, even in these days of market raj. |
| It started with the 2003 Union Budget when the finance minister announced that small firm loans up to Rs 50,000 should be capped at 9 per cent, or two percentage points below the banks' PLR. Since the banks were reluctant to implement this, the finance ministry was keen that the RBI should issue a directive to this effect. But the regulator, too, was uncomfortable with the idea. So the task was given to the IBA. |
| The association did the needful by circulating the relevant extracts from the Budget speech within the industry and asking banks to take their board approvals to fix the lending rates for small farmers. With most of the banks' BPLR now less than 11 per cent, small farmers will get loans at 8.5 to 8.75 per cent. |
| A similar package has been announced for coffee growers, too. The Coffee Board had made a presentation to the commerce ministry asking banks to drop the interest rates on crop loans up to Rs 50 lakh, from 11 per cent to 9 per cent. |
| What's more, the board wanted this rate to remain effective during the current plan period that comes to an end in 2007. The banks had no choice but to cut the rates. However, they could, for the time being, resist the move to extend the concession up to 2007. The low rates will remain in effect for one year. |
| There was a demand to drastically reduce the cost of investment loans given to coffee growers to 6 per cent. This was also resisted. The initiative in this case, too, was taken by the IBA at the government's insistence. |
| The association will have another meeting on January 12 to consider whether a similar concession can be given to tea growers. Many more such schemes for small scale industries (SSIs) and other under-privileged segments of businesses are likely in the run-up to the elections. |
| Nobody denies the fact that a vast section of borrowers is not getting the benefit of the low rates. But can bankers be solely blamed for this? After all, they are following market forces. The AAA-rated industrial houses are bound to get loans cheap. The villain of the piece is the government. |
| Why should any bank extend money to the risky small and medium sector if it can earn risk-free income by chasing sovereign paper? As long as government paper continues to flood the market, no bank will be interested in creating loan assets. |
| The incremental non-food credit of banks in the first nine months of the year (between April and December 12) is Rs 55,125 crore. This is far below banks' investment in government securities in this period "" Rs 97,197 crore. |
| It's clear that banks are putting more money in government papers than in advances. This is despite the rise in demand for retail loans like home and consumer loans. |
| On their outstanding asset portfolio, bank investment in government securities is around 45 per cent, against the statutory prescription of 25 per cent. However, on an incremental basis, bank holding of government paper works out to around 66 per cent of assets during the current fiscal year. |
| Since banks cannot be stopped from participating in the gilts market, the only way to force them to lend to small and medium industries is to stop floating government paper. But this is not possible when a widening fiscal deficit stares the government in the face. Drastic pruning of expenditure could cut the fiscal deficit. |
| Alternately, with the "India shining" story gaining momentum, the government can consider floating sovereign paper abroad. India does not enjoy investment grade status as yet but things may change soon as both the global rating agencies "" Moody's and Standard & Poor's "" are fairly upbeat on the country. |
| Floating sovereign papers overseas has other implications but it can force the banks to change their business model. When gilts are in short supply, they will be forced to lend to those segments of businesses where they fear to tread right now. |
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