‘Short-term money likely to become cheaper under new base rate regime’

With the Reserve Bank of India telling banks to price all rupee loans with reference to the Marginal Cost of Funds-based Lending Rate (MCLR) with effect from April 1, 2016, companies can hope to get short-term loans (of less than one-year duration) at competitive rates vis-à-vis commercial paper. Currently, base rate is the floor rate below which banks cannot lend. However, they can invest in commercial paper (short-term money market instruments) issued by large rated corporates even if the interest rate is below their base rate.

So, a large universe of companies, which cannot approach the CP market due to rating constraints, have no choice but to go for short-term borrowings at base rate (plus a spread). The interest rate on the loan is the same, irrespective of whether its tenure is three months, six months or one year. The new base rate regime seeks to correct this anomaly as banks will come up with internal MCLR benchmarks for various tenors, such as overnight, one-month, three-months, six-months and one year.

Rajnish Kumar, Managing Director, State Bank of India says that the new methodology for working out interest rate on advances could prove beneficial for companies that are not in a position to raise short-term resources via commercial paper.

In an interview to BusinessLine , Kumar explained the nitty-gritty of the new base rate regime and its impact on banks and borrowers. Excerpts:

How will the new base rate regime help borrowers?

The existing base rate was not capturing the maturity profile of the assets. Now our base rate is at 9.30 per cent. So, we can’t lend below this rate.

But if a corporate wants to borrow for, say, three months, the rate for one year as also three months is 9.30 per cent. With the new method of computing interest rates on advances, there will be differentiation. So, short-term money is likely to become cheaper.

However, in the case of long-term money, it may not affect that much.

For example, take the case of housing loans. Today, we charge interest rate at 20 basis points (spread) over the base rate (of 9.30 per cent).

So, the borrower is charged 9.50 per cent interest. Now, going forward (from April 1, 2016), what is going to happen is that you will have a choice. Suppose, you want one-year (loan) reset, the rate charged will be one-year MCLR plus the spread.

So, the spread will remain fixed. That will not change, at least, in the case of home loans.

I can’t say this in the case of corporate credit because it is a function of risk rating and all that. But in the case of home loans, we are not doing risk rating; so the spread remains fixed. We give it on a portfolio basis.

So, today, suppose my MCLR for one-year is 9 per cent and my spread is 20 basis points over MCLR. So, the interest rate to the borrower is 9.20 per cent. After one-year, suppose my MCLR goes down to 8.50 per cent.

You will get the loan at 8.70 per cent. If the MCLR goes up to 9.50 per cent, you will get it at 9.70 per cent.

But whatever changes (in interest rate) happen in between, your loan will not get re-priced.

The borrowers who are borrowing short-term, depending on the interest rate scenario, will be able to get that benefit.

Suppose, the interest rates go down, people who resort to short-term borrowing — one month, three months, six months — they may get money cheaper.

But in a rising interest rate scenario, the reverse can happen. So, it works both ways.

What is the benefit for banks?

For banks, I believe, though we are yet to do calculations, the asset-liability management will become better.

Transmission (of changes in policy rates) will happen in the short term. That is the basic idea (of the regulator to prescribe the new methodology for computing interest rates on advances).

There was a time when corporates were able to raise short-term money at 6.5 per cent, 7 per cent. This was when the overall interest rates were lower and the restriction that you can’t give money below the benchmark lending rate was not there.

During that period the lending market was more aligned to the money market.

But when the base rate became the floor rate, the credit and money market alignment in the shorter cycle got distorted because of the base rate restriction.

Now, if banks do proper asset-liability management under the new methodology for calculation of interest rate on advances, they can still protect their net interest margin. We invest in commercial paper.

Now, suppose a corporate that doesn’t want to go to the CP market comes for a loan of three months. Currently, I can’t lend at less than 9.30 per cent but can invest in a three-month CP at 7.50 per cent.

But when we do move over to the MCLR-based lending, the loan will be at three-month MCLR, which would depend on our three-month cost of borrowing.

This is how the monetary policy transmission will take place. Not everybody can tap the CP market. Only bigger, rated corporates can approach the money market. This is not possible for everyone.

There is a large universe of borrowers who cannot approach the CP market. So, these customers, I believe, in a falling interest rate scenario are likely to benefit from it.

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