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Banks: Transparency finally

Feb 26, 2003

The RBI has asked scheduled banks to disclose their lending rates. But shouldn’t banks themselves be disclosing this data on their own? Why has the apex bank felt the need to make this demand? The reason is that the RBI is worried that the benefits of a soft interest rates scenario is not being passed to all classes of borrowers.

To put this in perspective, the table above indicates the falling trend of maximum prime lending rates as well as maximum interest rates over a period of the last 8 years. We can see that the deposit rates have fallen at a faster rate than the PLR. The PLR was high at 12% even in FY02. In fact, companies like L&T and Reliance have been able to borrow from the money markets at the rate between 6-7% in FY03. Assuming that the PLR for FY03 has fallen to 10%, the differential between the blue chip lending rates and the PLR rates is still very high.

Due to excess liquidity in the debt markets, companies with very good credit rating have been able to raise capital at cheaper rates. Banks due to lack of safe investment opportunities (other than government securities) have been investing in the debt instruments of these companies. But on the other hand, these banks maintain a high PLR rate. This means that companies with a poor credit rating may not be able to borrow at sub PLR rates, and may be forced to borrow at PLR or above PLR. With the inflation ruling at close to the 5% mark, the real interest rate is still very high.

This creates a vicious cycle. Banks keeping in mind their earlier experience with NPAs, are forced to invest in debt instruments of companies who have a high credit rating. This leads to increased liquidity in the debt markets. However, in order to protect their interest margins, banks have resorted to keeping the PLR at high levels. So, in effect, these high PLRs discourage a large section of the industry from borrowing. This is in a way is detrimental to the economy as there is a lack of credit offtake from the industrial sector. Even if these company’s borrow at high PLRs, owing to the current economic environment, it becomes difficult for them to service their debt, which again leads to the banks’ NPA accumulation and hence, gives rise to reluctance by banks to finance companies with lesser ratings.

RBI’s new step may go a long way in bringing transparency to the whole lending operation of banks. This coupled with the recent NPA bill giving powers to banks to recover their dues, is likely to go a long way in boosting credit off-take by companies with relatively lower credit rating, at the same time covering the bank’s risk to an extent.

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