The chairman of State Bank of India Pratip Chaudhuri never tires of making this statement: “If a hotel company comes and asks for a four-year loan, I tell them please take a seven-year loan; you just can’t service it in four years”.
Sounds strange, but bankers are learning the appropriateness of this approach, in some cases, the hard way. The spate of non-performing loans (NPLs) could be blamed on the economy, but bankers admit that aggressive estimates of borrower cash flow trajectory are also doing them in.
We will point out two areas where this thinking could be pertinent. The obvious is project loans, especially for infrastructure—well-documented, so there is little to explain. But not just infrastructure projects—education loans face the same problem. A senior executive of Indian Banks Association mentioned to this author: “Instead of blaming the economic downturn for deteriorating quality of education loans—NPLs close to 6%—we must realize that nowhere in the world education loans are paid off in four-five years as we expect students to do here. In some countries, you repay till retirement”.
Banks’ maturity profile disclosures show only some faint signs of loan tenors elongating, though of course, this disclosure is not conclusive enough as it reflects residual tenor and gets distorted by changing loan composition. For example, the “over three years” category for State Bank of India went up from 26% of loans in FY2007 to 29% in FY2012. However, for ICICI Bank Ltd, the journey has been reverse as their retail lending went through a tumultuous phase: the “over three years” category went from 32% in FY2006 to 40% in FY2009, and dropped to 29% in FY2012.
With business cycles getting shorter, downturns are more frequent than before. So paradoxically, shorter tenor loans are not less risky any longer; in fact, a longer tenor may make repayment easier. Moreover, project approvals have become significantly more cumbersome, unlikely to get better any time soon. On the retail loan side, job and salary stability is decreasing, impairing repayment ability. Planning for a longer tenor makes eminent sense in this climate.
It is better to start with a longer tenor at the beginning rather than restructure the account mid way. Other than the financial implications for the bank, which are on the rise, this leads to a serious image problem as high restructured assets are now looked upon as the same as high NPLs, never mind exhortations to the contrary. With longer tenors, the Reserve Bank of India would have less reason to make NPL recognition more benign, which weakens the system fundamentally.
For a system that has grown on wholesale, development financing model till the 1990s, the thought of longer tenors should come naturally. However, ever since two major domestic financial institutions converted to banks, they have been consciously striving to change their business model to the exactly opposite. On the other side, bulk of the banking sector is still learning the ropes of longer-term financing, or more appropriately, suitability of a certain tenor for a borrower. The odd bank or domestic financial institution that raises the issue of too short a tenor may not be heard in a consortium of lenders dominated by banks who think otherwise.
Lengthening of tenors of loans started in a major way from the mid-2000s in retail loans, with seven-year car loans and 20-year home loans. Prior to that, getting anything longer than a three-year car loan or 10-year home loan was difficult. These products were aimed at market expansion rather than enhancing repayment ability. Presently, the latter objective has become a key driver.
If banks have managed to make 20-year home loans, there is no reason for them not to consider suitable, longer tenor for other products. True, for a home loan, the collateral typically appreciates. But this is certainly not true for a car loan, and car NPLs have not swung out of control because of borrowers handing over their keys to the lender midway, on relative judgment of the residual value versus outstanding loan balance.
For the sake of completeness, let us mention the standard objection to this, which has largely been rubbished by now - asset-liability mismatch (ALM). Except for crisis periods like post-Lehman, the deposit rollover rates are so high in India that managing ALM is far easier than in developed countries. Had ALM been so much of a problem, banks would have lapped up India Infrastructure Finance Co’s refinancing product, which they have not.
Gone are the days of rigidities such as a steep yield curve which could force the borrower to opt only for shorter terms. The plain-vanilla structure of a term loan has also undergone a change - there could be a variable rate across the duration, and possibly even linked to borrower profitability or other water-marks.
Dipankar Choudhury has been a senior research analyst on financial services as well as other sectors at various investment banks, and is currently an independent consultant focusing on banks and financial services.