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C. Shivkumar

Bangalore, Aug . 13 With certificates of deposit (CD) headed to breach the 11-per cent mark on the back of tight liquidity, banks have started waiving penalties for loan prepayments.

Prepayment penalties were mostly levied by the domestic private sector and foreign banks. The penalties ranged anywhere between one and three per cent of the outstanding loan principal amount. Public sector banks have long done way with the prepayment charges. But private sector banks have now followed suit.

ING -Vysya Bank sources said, “We have already done away with penalties on partial prepayments.”

Banks typically resisted prepayments when interest rates were low and liquidity was in surplus.

Bankers said that the move was influenced by tight liquidity conditions and soaring costs of working funds.

Three- month CDs were raised at 10.5 per cent. Inclusive of costs for maintaining mandated reserve ratios (cash reserve ratio of 9 per cent and statutory liquidity ratio of 25 per cent), the effective costs were closer to about 11.5 cent on the funds raised through CDs, bankers said.

CDs are treated as part of banks net demand and time liabilities and consequently eligible for both CRR and SLR. Bulk deposits through CDs comprised at least 30-35 of private sector bank lendable resources. In the case of foreign banks, the ratios were closer to about 40 per cent. Besides, retail deposits were also close to 10 per cent.

Bankers said that till the middle of last year, many banks had securitised some of their home and auto loan portfolios. The securitised papers were placed them with other financial institutions that included mutual funds and insurance funds. Such resources were free from reserve ratios.

Prepayment of outstanding loans also had the advantage of being free from reserve ratios and allowed banks to augment lendable resources.

As for the foreign banks, some had raised cross -border resources for meeting their lending requirements. Part of the cross-border resources was short term in nature which consequently had the inherent risk of mismatches. But cross- border funds were also no longer cheap, unlike in the past.

Moreover, the migration to Basel II also pushed banks to reduce the risk-weighted assets on their books. This year, the entire banking sector is expected to become compliant to BASEL II. A shrunk asset book reduced banks’ capital requirements. This was particularly in a situation, when even capital funds in the domestic and international markets were becoming increasingly difficult. Domestic banks have faced pricing pressures for making tier two bond issues. Tier two capital bonds for public sector banks are currently priced at well over 11 per cent, including placement and reserve ratio costs.

Bankers also said that in the current environment of hardening interest rates, delinquency risks mounted. Delinquency imposed far higher costs on the balance sheets than prepayments, they added. This was because the process involved large provisioning or preparing for a write-offs that could translate into losses.

More Stories on : Banking | Credit Market | Fixed Deposits

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