The shift from a benchmark prime lending rate (BPLR) to a base rate regime has been kicked off with State Bank of India (SBI) saying its base rate will be 7.5%. Clearly, India?s largest lender doesn?t want to outprice itself, although it?s possible that a couple of the newer private sector banks may price themselves a tad more competitively. They can afford to do that because they?re more efficient and are allowed to be so. But SBI doesn?t need to worry about them; no big borrower would want to end up in its bad books. And there are ways of compensating big corporates who may feel they?re being charged too much. The other public sector banks will almost certainly follow the leader; it?s unlikely any one of them will have a rate that?s meaningfully lower than that of SBI?s, if at all they do decide to undercut the market leader. SBI hasn?t really spelt out how it arrived at 7.5% but the number doesn?t really seem out of sync with the cost of money today. AAA companies today are able to borrow at around 6.5% or thereabouts. In a rising interest rate scenario, this could go up to about 7% or slightly higher. On the other hand, a one-year term deposit today costs banks barely 6%, although they may be forced to increase this by at least 50 basis points or more if the demand for credit picks up. Already, the pace at which deposits have been growing has slowed over the past few months.

To be sure, the base rate may be just an indicative reference rate because obviously banks will add a spread, depending on the quality of the customer, to arrive at the final lending rate. However, it is an important rate because no bank can lend below the base rate, except to some small-ticket borrowers, bank employees and those who borrow against deposits. It?s a floor that cannot be breached and therefore, has some sanctity.

For sure, more creditworthy companies aren?t about to see their interest costs shooting up; they will shop for credit and it?s possible that a couple of private sector banks will be more than willing to lend to them at less than 7.5%. Else, they will pick up some part of their requirement through short-term instruments like commercial paper, as the base rate does not apply to that mode of lending. Indeed, short-term bonds could proliferate. Why shouldn?t banks lend to large companies at fine rates? After all, they aren?t just focusing on plain vanilla credit when they deal with big companies; they?re also pencilling in fees from other services they could offer. As for small companies, if it?s true that they were being overcharged without being given an explanation, they will at least know on what basis they are being charged a certain rate. At the end of the day, it would be unjustified for SMEs to expect that they can borrow at anything less than what their risk profile commands.

Will the new system ensure that interest rates are transmitted more efficiently across the system, or in other words, will banks quickly heed the signals sent out by the central bank? In the past, the central bank hasn?t always been able to get banks to change rates in line with the levels signalled by them. It?s hard to tell how things will work this time around but the new system may be more effective since there is a floor in place. In a competitive environment, however, it?s only natural that banks would tweak their rates, either for loans or deposits, depending on their individual business economics and strategies. Ultimately, they will look out for their bottom lines of course, making sure that they don?t damage their balance sheets.

It?s true that the BPLR method didn?t work and that banks were lending below it. But in all fairness, even after the downturn in the Indian economy, which started in late 2008, the level of non-performing assets in the system didn?t really endanger any bank, though it is a fact that a large amount of loans have been restructured. If at all, it was the huge quantum of retail lending, without proper assessment of the credit risks involved, that resulted in huge non-performing assets for a couple of banks. The rate at which the loans were given had less to do with the defaults. Banks may believe that the base rate leaves them with less flexibility, although they have a window of six months to adjust, but since the central bank itself has suggested that the base rate be reviewed at least once in a quarter, it would imply that it wants banks to make changes if necessary. In a competitive market, banks will be compelled to keep costs in check and get cracking on their processes so that customers get their money fast. Otherwise they won?t be left with too many good ones.

?shobhana.subramanian@expressindia.com