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MUMBAI : Banks are aggressively pricing long-term corporate loans to lure high-rated business customers from other banks amid surplus liquidity, tightened credit standards and weak demand.

Lenders—mostly those in the private sector but also a few large public sector banks—are offering long-term loans at the repo-linked benchmark rate, which offers lower interest rates than those based on the marginal cost of banks’ funds.

“With too much liquidity and no credit growth options, banks are finding it difficult to put surplus liquidity to good use. They are giving long-term loans at rates that are significantly lower. It is not advisable and could come to haunt them," said Soumya Kanti Ghosh, chief economist, State Bank of India on Monday.

Two years ago, the Reserve Bank of India (RBI) allowed banks to link all floating rate loans to an external benchmark lending rate instead of the marginal cost of funds based lending rate (MCLR).

MCLR is a tenor-linked internal benchmark, which means the rate is determined internally by the bank depending on the period left for the repayment of a loan. Unlike MCLR, EBLR is linked to an external benchmark like repo rate or treasury bills.

This was done to ensure that RBI’s action on key policy rates is transmitted in a timely and transparent manner to customers. With the banking system sitting on surplus liquidity of over the past two years, banks felt the need to link even corporate loans to EBLR, which is mostly the repo rate.

Ghosh had pointed out this discrepancy in a note in November 2020, where he said that loan rates are lower than equivalently rated bonds. “Such type of irrational pricing, because of abundant liquidity, can impact banking sector profits and initiate asset-liability mismatch if the spread is more prevalent for lower-rated borrowers, a sure recipe for financial instability in the future.

“However, it is also true that high-rated corporates float bids for getting competitive pricing of their long-term or short-term loan requirements and various banks to participate in the same," said the note.

But private sector bankers say although a 10-year loan is offered at interest rates that are lower than a 10-year government security, these loans are secure as they are given to high-rated public sector undertakings. Such loans are mostly taken to refinance loans from other banks.

“It’s a question of demand and supply. It is better to earn a slightly higher rate on the surplus liquidity by lending to well-rated corporate rather than lend in the overnight window," a private sector banker said, requesting anonymity.

With long-term loans allowed to float and deposit rates fixed, this could potentially lead to an asset-liability mismatch. The banker said this kind of lending can only be done by banks with a higher current and savings account (CASA) ratio. “Cost of funds has to be continuously brought down. You cannot take corporate deposits because they would ask for a higher deposit rate. Hence, banks would need to keep their cost of funds low by borrowing at a lower rate and keeping high CASA proportion," he added.

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