Mumbai: State Bank of India (SBI), the country’s largest lender, pegged its base rate at 7.5% on Tuesday, setting the stage for a new bank rate regime that will take effect on 1 July. SBI’s base rate replaces its benchmark prime lending rate, or BPLR, of 11.75%.
At least six other public sector banks, including Punjab National Bank and Bank of Baroda, announced their base rate—all pegging it at 8%. Private banks, including ICICI Bank Ltd, India’s second largest lender, and HDFC Bank Ltd, will announce their rate on Wednesday.
For every bank, the base rate is lower than the BPLR which it replaces, but that does not necessarily mean that the cost of money will decline for borrowers. This is because no bank will be allowed to price loans cheaper than the base rate.
The new regime has been put in place by the Reserve Bank of India to ensure that small businesses don’t end up subsidizing below-BPLR borrowings by top-rated firms that have been able to raise funds at much lower rates.
Until now, around 70% of borrowers have been raising money at below BPLR. Although the BPLR of most public sector banks ranges between 11.5% and 12.5%, triple A-rated corporate borrowers were raising short-term loans at a rate as low as 6.75-7%.
Private banks are expected to set their base rate lower, but their public sector counterparts are not worried about losing customers to the competition.
Even if there is a wide divergence between the base rate of a private bank and a public sector bank, there won’t be much of a difference in the final applicable rates, SBI chairman O.P. Bhatt said. Customers getting loans at less than 7.5% account for only 3% of SBI’s corporate portfolio.
Bank of Baroda chairman and managing director M.D. Mallya said that even before the introduction of the base rate, private banks had been giving some loans at a cheaper rate than public sector banks.
SBI’s Bhatt does not see a dramatic change in loan rates under the new regime. “(The) rates could be different in most cases for new customers, but difference could be about 0.25% and not more,” he said.
Bhatt did not say what will be the spread on the base rate for home loans and auto loans. SBI currently charges 8% for the first year for any home loan.
He hinted that the bank could continue with the existing home loan rate as “it is anyway above our base rate.” The bank will announce its home loan rate on Wednesday.
Top-rated corporations may continue to raise ultra-cheap money from banks not in the form of loans, but financial instruments such as commercial paper. They can even raise medium- and long-term money through bonds and debentures. Instead of giving loans, banks can subscribe to commercial paper, bonds and debentures.
Commercial paper is an unsecured, short-term debt instrument issued by a company, typically to meet short-term liabilities. The debt is usually issued at a discount to its face value.
This will lead to a structural change in banks’ balance sheets as instead of showing them as loans, banks will need to classify such exposures as investments.
Unlike loans, investments run the risk of interest rate volatility. When bond yields rise and prices drop—they move in opposite directions—banks are required to set aside money to cover the drop in market value of their investments.
In accounting jargon, the practice is called marking to market or valuing a financial asset in accordance with its prevailing market price and not the price at which it is bought.
Hatim Brochwala, an analyst with Mumbai-based brokerage Khandwala Securities Ltd, said the banks will limit their exposure to such instruments when the liquidity in the banking system dries up.
“I expect demand for commercial papers to rise slightly and not much. Eventually, companies may not find it that profitable to come to this market as interest rate will also go up in these papers due to a possible over-supply,” said Brochwala.
Companies are, however, not overtly concerned. “We are an AAA-rated company and the impact won’t be much for us because 85% of our funds come from taxable bonds, commercial papers and external commercial borrowings,” said H.D. Khunteta, director (finance) at Rural Electrification Corp. Ltd. The company raised Rs3,000 crore last year at 7.38%.
“We expect interest rate to increase for new borrowings, but there is no compulsion to borrow from banks. We can look for other cheaper sources like external commercial borrowings,” Khunteta said.
Vinod Juneja, managing director of Binani Cement Ltd, said the base rate will increase its cost of borrowing.
“Our current borrowing rate from banks is 9-9.5% and with the base rate kicking in, it will go up,” he said, adding, “I don’t know on what basis they will calculate the costs.”
Whether borrowers will benefit under the new regime or not, one thing is for sure: banks are explaining the rationale behind the base rate, making the process more transparent. For instance, SBI has taken the six-month deposit rate as its main input to calculate its base rate.
Bank of Baroda, in contrast, has taken the average cost of deposits in the last quarter to arrive at its base rate.
“If we take one-year deposit rate (as the primary input for the base rate), it will not catch the current interest rate fluctuation. Similarly, the three-month deposit rate will not catch the historical rate movement,” said Bhatt.
Old customers of all banks can continue with their existing rates for at least a year, but new customers will be given loans based on a bank’s base rate.
Going by the Reserve Bank of India’s guidelines, banks can fine-tune their system of arriving at the base rate until December and from 2011, they can change their base rates at least once in three months.