Mispricing in wholesale lending continues to be a challenge: KVS Manian

Mispricing in wholesale loans due to intensifying competition is posing a challenge for banks in terms of RoA (return on assets) in their wholesale loan portfolio, according to Kotak Bank’s Whole Time Director KVS Manian.

“Pricing is a challenge. There is a lot of mispricing that happens in the market. Corporate lending is a quick and easy way to build a balance sheet. The temptation to write a large cheque and show growth is very high. But it destroys value for the bank stakeholders if not done judiciously,” Manian told businessline.

The tendency to misprice is very high for several products, but also with several clients and customer segments, he said, citing the example of non-fund based products, which he believes are widely mispriced as the risks are not as low as the pricing seems to indicate.

Return on Equity

“RoEs are not good enough in many of those products. Also the market misprices long-term loans. Premium for the tenure risk and credit risk from the tenor point of view, is not priced well enough,” he said, adding that differential credit spreads between a ‘BBB’ loan and a ‘AA’ or ‘AAA’ loan are “not good enough”.

Further, there are segments which may be good in terms of credit risk but where it is difficult to get transaction banking or business, and thus onboarding them without these non-risk revenues doesn’t make sense.

“Let’s say high rated PSU or MNC companies. It’s very easy to take risk on them. But on the deposit side, you bid for the highest rate and on the loan side for the lowest rate, and there is no transaction banking business because they will give it to either PSU or MNC banks. How do you make money?” he said.

Risk-return trade off

Kotak Bank is extremely conscious of the right balance and the approach to corporate lending is based on the risk return trade-off or what is called the RAROC (risk adjusted return on capital) to ensure the RoE (return on equity) is attractive.

“The moment we write a loan, we have to be sure that we get other businesses such as transaction banking, foreign exchange, debt capital markets, investment banking, employee salary business etc,” Manian said.

“If we can get a secular 15-20 per cent kind of growth in this business, we are fine with it. Our profits must grow faster than that and our RoE has to be retained. In good cycles, we’ll be able to operate at the higher end and in challenging times we may be operating at the lower end,” he added.

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