State-run companies have had an upper hand in loan pricing, but other firms are catching up
Banks have been parking over ₹7 trillion daily on an average under the reverse repo operations
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Flush with liquidity and increased competition, lenders are witnessing reduced spreads across their loan portfolios. A loan spread is the difference between the base lending rate and the final interest rate charged to the borrower.
While spreads on retail loans, especially mortgages, have been falling, there is intense competition among banks to woo top-rated corporate customers. Though bulk of the incremental lending is in retail, which offers better margins, some top-rated state-run companies are raising funds at the repo rate of 4%, without any spread, said experts. To be sure, state-run firms have had an upper hand in loan pricing, but this time round, other borrowers are also not far behind. “Clearly, banks are facing significant margin pressures," said Soumya Kanti Ghosh, chief economic adviser, State Bank of India, in a note on 21 September. He said weak credit demand and excess liquidity is evident with banks parking more than ₹7 trillion every day on average since April under the reverse repo operations of the Reserve Bank of India (RBI), while the government’s cash balance with the central bank is at ₹3.4 trillion.
At current rates, three-year term loans are being priced at close to 4% and seven-year term loans for borrowers below AAA are quoting a risk premium of 15-20 basis points over the 10-year rates, Ghosh said.
Bankers are also calling for a reduction in liquidity as there are fewer opportunities for credit deployment, leading to mispricing of loans. On 1 September, RBI governor Shaktikanta Das clarified that variable rate reverse repo (VRRR) auctions will remain the main instrument to absorb excess liquidity from the banking system. The VRRR has ensured that the cost of short-term borrowings does not fall below the floor rate, which is currently at 3.35%.
“Because of the lack of a multitude of instruments, liquidity surplus reached to the tune of more than ₹10 trillion. We have to bring it down in phases to ₹5 trillion as early as possible and then bring it further down to ₹3 trillion, irrespective of the view on inflation. To suck out liquidity, RBI can look at long-term reverse repo may be in 28 days or 56 days," said Jayesh Mehta, managing director and India country treasurer, Bank of America.
The central bank has said it will support growth as long as it is required and has retained its monetary policy stance to accommodative. In the aftermath of the pandemic, it has lowered its repo rate by 115 basis points to 4%. Reverse repo, the rate at which banks park excess funds with RBI, is at 3.35%.
A section of industry executives said while banks have been facing margin pressures due to the liquidity build-up, the central bank must raise the reverse repo rate. “Margin pressure has been happening since the build up of liquidity in the system and banks are parking significant sums of money under the reverse repo window. However, banks are also seeing good growth of current account and savings account (CASA) deposits, which is even higher than the term deposit growth, giving them access to cheaper funds," Anil Gupta, vice-president and sector head, financial sector ratings, Icra, said.
Some others are of the opinion that lax underwriting is a bigger risk to margins than the rate war, as banks have been able to manage their cost of funds well. “There has been margin pressure, but it has not been material. The reason is that banks are predominantly lending to retail, a relatively high-yielding segment. The margin pressure is limited to 5-10 basis points for the entire system, according to our estimates, and that is probably because of consistently declining loan-to-deposit ratios," said Saswata Guha, senior director, banks, Fitch Ratings.