Banks told not to vie for creamy loans

The Reserve Bank of India (RBI) has warned banks against competing to lend to top-rated corporates under the Basel-II regime, saying it could squeeze their margins. The new capital norms require banks to set aside lower capital for loans to corporates with higher credit ratings.

"The new framework could also intensify competition for the best clients with high credit ratings, which attract lower capital charge. This could put pressure on the margins of the banks. Banks, therefore, need to streamline and reorient their client acquisition and retention strategy," said V Leeladhar, deputy governor, RBI, at a banking conclave organised by the Ficci and the Indian Banks' Association (IBA).

Loans to best-rated corporates will attract a risk weight of 20 per cent, while loans to lowest-rated corporates carry a capital charge of 150 per cent. Indian banks having overseas operations and foreign banks operating in India need to comply with the Basel-II norms by March 31, 2008. All other banks are required to adopt the new framework by March 31, 2009.

Under Basel-II, the risk weight for loans to AAA-rated companies is just 20 per cent against 150 per cent for BB or lower-rated companies. This means banks would have to provide only Rs 1.8 of capital for every Rs 100 lent to an AAA-rated corporate, while they would need to set aside Rs 13.5 of capital for loans to corporates rated BB or lower.

Since May 2006, banks have been conducting parallel runs to compute their capital adequacy ratio (CAR) both under Basel-I norms as well as under the proposed Basel-II guidelines.

"The reports received in the RBI indicate that implementation of Basel-II in the banks is in the process of being stabilised. The major banks are in a position to meet (the capital) requirements," said Leeladhar.

The capital adequacy for banks averages to 12.5 per cent. The new capital norms could have an impact of up to 2 percentage points on the banks' combined capital adequacy, but the impact on individual banks would vary depending on the risk profile of their respective loan portfolios.

According to Leeladhar, if the additional capital required for operational risk under the new norms is not offset by the capital relief available for the credit risk, it could lead to an increase in the overall capital requirements for banks. Banks would need to be prepared to augment their capital through strategic capital planning.

While public sector banks are constrained in raising equity capital as their government holding has to be maintained at 51 per cent, Leeladhar said these banks should not face any problem for the next two years. The government would have to take a call (on reviewing its holding) after two years.

The biggest challenge for banks would be to provide for all the risks not covered under credit risk, market risk and operational risk by putting in place a board-approved Internal Capital Adequacy Process (ICAAP). The validation of internal models of banks by supervisors would also be an arduous task, said Leeladhar.

Banks would also have to keep in mind that the borrower's credit rating only provides a lagged indicator of the borrower's credit standing and is not a lead indicator.

"Banks would, therefore, need to reckon actively this aspect in their (ICAAP) exercise," said Leeladhar.