Can you ask Hindustan Unilever Ltd (HUL), India’s largest packaged consumer goods maker, to give a break-up of the cost of vegetable oils, tallow, sodium hydroxide, pigments and fragrances that are used to make soap? And the cost of packaging, dealers’ commission and the margin that it wants for every cake of soap sold? If you can’t do that, why do you expect banks to be transparent and reveal their cost of funds, overheads and margins while pricing loans?
A highly agitated senior banker told me this last week after the central bank issued a statement freeing all loan rates and replacing the benchmark prime lending rate (BPLR) with a new concept called base rate, below which no bank will be allowed to lend from the next fiscal, beginning 1 April. The Reserve Bank of India (RBI) wants banks to be transparent while fixing the rate. According to this banker, RBI’s move will deal a blow to the market economy. “Let the borrowers reject the banks that are over-charging. Why does RBI want to get into micro-management?” he argued.
Banking is not like selling soap and money—the raw material bankers use—is very different from what goes into making of Lifebuoy and Lux. Nirma Ltd could flood the rural market with its low-cost detergent and force HUL to rework its pricing strategy, but this kind of competition cannot take place in banking, a highly regulated business. Which is why protection of consumers is the regulator’s headache.
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Banks are being asked to shift to the base rate because they were misusing BPLR by offering loans to many corporations below BPLR while over-charging others.
Small and medium enterprises (SMEs) have been raising bank loans at 3-4 percentage points higher than BPLR in contrast to the top-rated corporations whose cost of loans is 3-4 percentage points lower than BPLR. In other words, SMEs were subsidizing the larger and stronger firms. The new base rate is nothing but MLR, or minimum lending rate, and many bankers are not comfortable with it for fear of losing the power of discretion in fixing loan rates.
Incidentally, the Telecom Regulatory Authority of India lays down the basic pricing norms for cellular phone firms. In the financial sector, the Securities and Exchange Board of India decides on how much commission a mutual fund can charge and the Act that governs the insurance industry has fixed the ceiling for commission on the sale of insurance products.
Bankers will find it difficult to have one base rate for all loans. The cost of short-term money is less and hence short-term loans will always be cheaper than long-term loans, they say. If indeed that’s the case, why are they offering 20-year mortgages at 8-8.5%? There is something rotten in the current loan pricing system. If the long-term loans are floating rate loans, where the price is adjusted periodically, then it’s not very difficult to link all loans to the base rate, irrespective of their tenure. To be fair, bankers alone shouldn’t be blamed for distortions in rates. Unlike other developed markets, in India the policy rate does not have a direct bearing on banks’ loan rates because the monetary transmission mechanism is very weak. Which is why, despite a 5.75 percentage points drop in the policy rate since October 2008, in the wake of the collapse of the US investment bank Lehman Brothers Holdings Inc., banks did not pare their BPLR by even half of it. Also, there is no correlation between banks’ loan rates and government bond yields.
In the US, the prime rate, which is normally 3 percentage points higher that the Fed rate, is the benchmark rate for all consumer and retail loans while the London inter-bank offered rate, or Libor, is the reference point for all corporate loans. Similarly, in the UK, the Bank of England’s base rate is the benchmark rate for consumer and retail loans while Libor influences commercial loans. In India, neither repo (the rate at which the central bank infuses liquidity into the system) nor reverse repo (the rate at which RBI sucks out liquidity from the system) has any bearing on the actual loan rate of banks. And the bank rate of RBI, its medium-term signal rate, is defunct. It was last changed in April 2003.
Libor’s Indian counterpart is Mibor, or the Mumbai interbank offered rate—the rate at which banks can borrow funds from each other in the interbank market. Launched in June 1998, Mibor is calculated daily by the National Stock Exchange as a weighted average of lending rates of a group of banks. The success of the overnight Mibor encouraged the exchange to develop one-month and three-month Mibor but these term rates are not as effective as they should be. One of the key reasons why the term money market virtually doesn’t exist in India is an imperfect government bond market. The government borrows from the market every year to bridge its fiscal deficit and RBI, the banking regulator, manages this programme.
There is a clear clash of interest between the role of RBI as banking regulator and the government’s debt manager as it would always like to keep the yield on bonds at a low level to ensure smooth implementation of the borrowing programme at a low cost for the government. An independent debt manager for the government will help develop the term money market as bond yields will be more realistic, but that may not happen until the fiscal deficit declines.
We will wait for that, but meanwhile RBI should kill the bank rate. Nobody will miss it.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as Mint’s deputy managing editor in Mumbai. Email your comments to email@example.com