Whats The Use Of A Prime Lending Rate?

Many AAA names, eligible for PLR, are raising cheaper money through the bond market and commercial paper markets. Name one AAA company whose average borrowing cost is equal to PLR and Ill show you a company with an inept treasury.

The companies lower down the pecking order are not benefiting either. If anything, they are probably paying higher spreads over PLR to compensate banks for the other assets booked at sub-PLR.

Even though banks have taken to the concept of a PLR quicker than a proverbial duck to water, and introduced their own short-term, mid-term and long-term variants, they stand to benefit the most from not lowering their PLRs too much. Instead, to keep their AAA clients, banks have evolved ways to make loans at below PLR.

Having grown used to demands for sub-PLR loan requests from AAA corporates sooner than later, because of the glut of money banks have been merrily lending sub-PLR.

Indeed, ever since April, when banks were allowed to lend rupees against FCNR(B) deposits, they have been lending those funds at sub-PLR rates to prime companies to build up their incremental asset book.

As a banker friend explained, this suits the banks as they do not want to keep lowering their prime rates just to attract good assets. This is because of the tremendous inertia in the banking system when it comes to swapping banks and accounts.

It is more profitable for banks to keep the PLR higher than it ought to be, as they have plenty of working capital accounts of less than AAA companies, which due to the paperwork and hassle associated with dissolving consortiums, are unlikely to move unless a banks rates are way off-whack.

So, as PLR rates come down across the system in a piecemeal fashion, corporates are unlikely to flit from bank to bank in search of a 50 basis points cut. Hence, banks have done the sums and have figured out that the best way to keep incomes rising is to keep PLRs at a higher level and build the asset book through sub-PLR deals.

Which means that banks were not overly delighted when the Reserve Bank aligned the FCNR(B) loan regime with the domestic interest rate structure -- this meant that they could not lend these funds at sub-PLR rates.

But, to quote another cliche, where there is a will there is a way. In order to be able to advance loans to their favourite clients at sub-PLR rates, banks have now begun designing unsecured non-convertible debentures for one year (NCDs can be for a minimum period of one year). In case the loans have to be for a shorter period of time, the bankers merely insert put and call options at the end of every quarter.

This way, loans can continue to be made below PLR to get good assets and the banks can make up the difference from the rest of the customers.

So, effectively, the whole reason for having introduced a prime rate (in order to put a competitive cap on the maximum spread a bank could charge a client) has come to nought.

This trend will be accentuated by the recent policy decision to re-link commercial paper (CP) limits and working capital ratings (makes the job for the rating companies easier Do you have a bank limit? Good, heres your P1 rating for the same amount.)

When the link between CPs and bank limits was severed by the RBI a few years ago, the CP market was limited to the P1+ issuers. Now, the market is set to balloon as P1 and P2 companies also get in on the act, knowing that they have bank limits to fall back upon.

Now, one can argue that this means more disintermediation from the banking system and to combat it, banks will lower PLR to woo clients back. However, since banks are the primary investors in instruments like NCDs and CPs, they are even less likely to tamper with their PLRs.

Now more than ever, given all that inertia in the system and preponderance of small companies who are unlikely to be very sophisticated in treasury techniques and thus are unable to use the financial markets to minimise costs effectively.

So pre-reforms, the governments borrowings were subsidised by other borrowers. Post-reforms, it is probably the top 100 or 200 borrowers who benefit from this interest subsidy.

Can these handful of companies provide the momentum for 7 per cent growth in the eco-nomy? Dont count on the smaller chaps; theyre doing all they can to survive.