Mumbai: In a move that could radically change the way banks do business in India, an internal panel of the Reserve Bank of India, or RBI, has suggested scrapping the concept of prime lending rate (PLR) or the rate at which banks are expected to lend to their top-rated customers and the mandated concessional rate for small loans, a person familiar with the development said.
The panel has already submitted its report and the central bank is expected to put this up on its website this week, ahead of its 27 October half-yearly review of monetary policy, for public comments.
The panel has suggested scrapping PLR and replacing it with a “base rate” and said no bank should be allowed to lend below this rate. Only short-term loans of up to one year and working capital loans to companies can be given below the base rate, the panel has said.
Lending reform: A branch of Punjab National Bank at Sampla in Rohtak district, Haryana. Currently, rates of all small loans given to agriculture and small-scale industries are mandated at 7%. Harikrishna Katragadda / Mint
The panel, chaired by RBI executive director Deepak Mohanty, was formed in June to review the PLR system and suggest an appropriate loan pricing system. Its mandate also includes a review of administered lending rates.
The six-member panel includes Jahangir Aziz, India chief economist of JPMorgan Chase and Co., T.T. Ram Mohan, professor at the Indian Institute of Management, Ahmedabad, and representatives from RBI and the Indian Banks’ Association, the apex bankers’ lobby, among others.
The base rate will take into consideration a bank’s cost of deposits, cost of operations and the margin that a bank needs to keep between the cost of funds and return on advances to make profits.
It will also factor in other critical operational aspects such as the cash reserve ratio (CRR), or the portion of deposits that banks need to keep with RBI and on which they do not earn any interest, and non-performing assets, or NPAs. Currently, banks are required to keep 5% of their deposits with RBI as CRR.
Banks also do not earn any interest on NPAs or stressed assets. On top of that, they are required to make provisions for such assets, all of which eats into their profitability.
Currently, rates of all small loans given to agriculture and small-scale industries are mandated at 7%, much below banks’ PLR.
Such loans are given at 7% and the government offers a 3% subsidy to banks on such loans through a budgetary provision. Besides, loans to exporters are also given at 2.5% below a bank’s PLR. Collectively, such loans account for about one-third of a bank’s loan book.
PLRs of public sector banks currently vary between 11% and 13.25%, and some private banks charge as much as 15.75%.
However, in most of the cases, such rates are of academic interest as around 75% of bank loans, by an RBI estimate, are disbursed at below PLR.
Banks keep their PLR at an artificially high rate as otherwise their earnings on some of the loans linked to PLR, such as export loans, will go down.
In fact, this partly explains why banks have not been able to bring down their PLRs in sync with the deep cut in policy rates by the central bank. RBI has pared its policy rate from 9% to 3.25% since October 2008, after the collapse of the US investment bank Lehman Brothers Holdings Inc. and the unprecedented credit crunch that hit the global financial system, but commercial banks have brought down their PLR by only 2.5-3 percentage points.
According to a senior public sector bank executive, the panel’s recommendations, if accepted, will lend a lot of transparency to the whole lending process. However, the banker, who is privy to the recommendations, conceded that calculating the final loan rate is complicated and needs more fine-tuning.
According to another banker, who also did not want to be identified as the panel’s recommendations have not been made public yet, the base rate could be in the region of 9%.
This means that no company will be able to access medium- and long-term bank loans at below 9%. Such a move will not make much difference to top-rated firms as they anyway access money at below PLR, but it will make the system transparent.