Full of money, lenders woo businesses with cheap loans

Lenders, mainly those in the private sector but also a few large public sector banks, offer long-term loans at the repo benchmark rate, which offers lower interest rates than those based on the marginal cost of funds of banks.

“With too much liquidity and no options for credit growth, banks are struggling to make good use of excess liquidity. They provide long term loans at significantly lower rates. It is not advisable and could come to haunt them, “said Soumya Kanti Ghosh, chief economist of the State Bank of India on Monday.

Two years ago, the Reserve Bank of India (RBI) allowed banks to tie all variable rate loans to an external benchmark lending rate instead of the marginal cost of funds (MCLR) based lending rate. .

The MCLR is an internal benchmark linked to the duration, that is to say that the rate is determined internally by the bank according to the remaining duration for the repayment of a loan. Unlike the MCLR, the EBLR is linked to an external benchmark such as the pension rate or treasury bills.

This was done to ensure that RBI’s action on policy rates is conveyed in a timely and transparent manner to clients. With the banking system sitting on excess liquidity for the past two years, banks have felt the need to tie even business loans to the EBLR, which is primarily the repo rate.

Ghosh had highlighted this discrepancy in a note in November 2020, where he said loan rates were lower than those on equivalent rated bonds. “This type of irrational pricing, due to the abundance of liquidity, can impact banking sector profits and initiate an asset-liability mismatch if the spread is more prevalent for lower-rated borrowers, a safe recipe for financial instability in the future.

“However, it is also true that well-rated companies are launching offers to get competitive prices for their long-term or short-term lending needs and that various banks participate,” the note said.

But private sector bankers say that while a 10-year loan is offered at lower interest rates than a 10-year government guarantee, these loans are secure because they are made to well-rated public sector companies. These loans are mainly taken out to refinance loans from other banks.

“It’s a question of demand and supply. It’s better to earn a slightly higher rate on excess cash by lending to well-rated companies rather than lending overnight, “a private sector banker said on condition of anonymity.

As long-term loans are floating and deposit rates fixed, this could potentially lead to an asset-liability mismatch. The banker said that this type of loan can only be granted by banks with a higher current account and savings ratio (CASA). “The cost of funds must be continuously reduced. You cannot accept business deposits as they would charge a higher deposit rate. Therefore, banks should keep their cost of funding low by borrowing at a lower rate and keeping a high CASA ratio, ”he added.