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Base rate system may drive firms to commercial paper

Base rate system may drive firms to commercial paper
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First Published: Wed, Mar 17 2010. 01 15 AM IST

Graphic: Yogesh Kumar / Mint
Graphic: Yogesh Kumar / Mint
Updated: Wed, Mar 17 2010. 02 57 PM IST
Mumbai: The introduction of the so-called base rate below which no bank can lend from July will give a leg-up to the commercial paper market in India as corporations and non-banking finance companies (NBFCs) will prefer them to bank loans for short-term funding needs, bankers and company officials said.
Commercial papers are an unsecured money market instrument issued in the form of a promissory note.
The cost of commercial paper will be cheaper than bank loans once the base rate system comes into effect as firms will no longer be able to negotiate interest rates with banks.
Currently, banks have a benchmark prime lending rate, supposedly reserved for the best customers; in reality, at least 70% of loans are given below this rate. Companies exact fine prices from banks for short-term loans, taking advantage of fierce competition among lenders. The rate of interest for a three-month loan can go as low as 5-6% for well-rated companies.
Graphic: Yogesh Kumar / Mint
In the new regime, banks will not be allowed to lend below the base rate, and hence, firms will not be able to raise cheap money. The base rate for most banks will be in the range of 8.5-9.5%.
“Volumes of commercial papers will increase because it will be cheaper for companies to raise money through this route rather than loans from banks,” said Paritosh Kashyap, executive vice-president at Kotak Mahindra Bank Ltd.
Companies issue commercial papers for short-term capital requirements ranging from 15 days to 365 days. The interest rate on commercial papers are linked to the yield on the one-year government bond.
As of 15 February, the outstanding commercial papers issued by local firms were worth Rs96,152 crore, up from Rs53,615 crore a year ago, data from the website of the Reserve Bank of India (RBI) shows. The interest rate varied between 3.3% and 8.0%, though RBI does not spell out the tenure of the papers.
Alpana Dave, assistant vice-president at Edelweiss Securities Ltd, said there is enough demand from investors for commercial papers. She expects NBFCs to raise more money through commercial papers than other companies.
“NBFCs backed by big groups such as Tatas, Bajaj and ICICI are likely to issue more paper than companies because they need money for their lending business,” she said.
V. Ravi, chief financial officer at vehicle finance company Mahindra and Mahindra Financial Services Ltd, acknowledged that his firm may have to look to issue more commercial papers once the base rate system takes effect.
Bankers say not all firms can raise commercial papers and the market is highly skewed towards better-rated companies.
Mutual funds and banks are the biggest investors in commercial papers. Banks, though, have internal limits on how much they can invest in these.
Debjiban Basu, general manager, treasury, United Bank of India, said banks may have to tweak internal investment models to accommodate more paper. “If we treat commercial papers as working capital loans, we will be able to invest more in these papers.”
Companies will also try to get better ratings because that will help them in raising loans at better rates, said S. Rajendran, general manager, treasury, Union Bank of India. “For companies that don’t have good ratings, commercial papers are not going to make much of a difference.”
For smaller firms, the fees for rating papers, stamp duty and other costs could make the cost of commercial papers higher than loans.
Large oil marketing firms may also lose out because huge losses have negatively affected their ratings. Currently, they are the biggest users of short-term funds.
Even though the cost of commercial papers will depend on the rating of a company, by and large, they will be cheaper than bank loans.
O.P. Bhatt, chairman of the country’s largest lender State Bank of India, has hinted that its base rate could be around 8%. For other banks, it is expected to be marginally higher. Currently, the cost of a six-month commercial paper for a well-rated firm is 6.65%.
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First Published: Wed, Mar 17 2010. 01 15 AM IST