How will banks and the corporate sector deal with the new rate structure and will it lead to a fairer regime?

With the base rate methodology of loan pricing set to kick in from 1st July, banks and companies alike will be gearing up for the paradigm shift it will usher into the Indian banking system. If analysts are to be believed, both banks and corporates will have to adjust themselves to the new system.

This new system is expected to change the way banks look at their loan books and bring about a greater transparency in pricing of loans. For corporates, it means that the days of easy loans are finally over, as they can no longer negotiate for rates lower than the benchmark prime lending rate (BPLR).

ASV Krishnan, senior analyst with Ambit Capital believes that some big companies may actually look for other avenues for funding. "Since banks will not be able to lend below the base rate, big corporates may not go for that avenue any more. They will need to look at alternative instruments. The commercial paper (CP) market will pick up as more and more large corporates will raise short-term funds by floating CP. Banks may subscribe to such papers. So for a bank, instead of generating advances, it will appear in investments."

From the bank's perspective, loan-book growth will need to moderate, feels Mr Krishnan. "The consensus Street estimate is a 20% growth in loan book. But if large corporates do not come for loans, then that will have to be revised downward. The Street may also need to price in a lower credit growth."

Another analyst, Nilanjan Karfa of BRICS Securities feels that current interest rate conditions will affect the corporate sector more than the base rate. "Since the overall interest rate regime is getting tighter, we could very well see RBI raising rates by 25-50 bps in the next policy. The overall liquidity situation is also tighter, which means that interest rates will go up. So this will have more impact on corporate loan rates than the base rate."

He agreed that transparency is, more or less, expected with this mechanism but feels that small companies need not necessarily benefit from the regime. "Earlier, banks used to lend at BPLR less 3%-4%. They used to adjust prices around a constant BPLR. So while Reliance was granted a loan at BPLR less 3%, a smaller company could only manage BPLR less 1%. Now, it will be the other way round. The bank will probably ask for base rate plus 1% from Reliance and base rate plus 2% from the smaller company. The pricing will still be based on the rating of the company you are lending to."

Deepak Tiwary, a banking sector analyst with KR Choksey said, "Earlier, small companies and SMEs used to subsidise the large companies, who were in a better bargaining position. They could ask for rates as low as 6%-7%. That will not happen now. So while large companies will be affected slightly, it is clearly good for the SMEs."

Mr Tiwary believes that the new structure will not impact banks' profitability much. "In case of a rise in interest rates, banks will be able to pass on the burden. It will not make much difference to them. Even in this regime, banks have enough room to manipulate in terms of the time horizon. Also, they can change their methodology to calculate base rate after six months."

The country's largest lender, State Bank of India (SBI) has fixed its base rate at 7.5%. This will set the tone for other banks, who will keep their own rates around the same mark to stay competitive in the market. It is believed that the industry as a whole will fix its base rate between 6.5%-8.5%. The industry is now eagerly awaiting what rate is fixed by the largest private sector lender, ICICI Bank, which is expected to make the announcement tomorrow. 

The time has officially come for all banks in the country to move on to the base rate method of pricing loans, as mandated by the central bank, the Reserve Bank of India (RBI), earlier this year. With effect from 1st July, all new loans in the banking system will be priced under the new mechanism, wherein banks will not be allowed to lend below the base rate.

Under the previous system, large companies were particularly used to preferential treatment on the part of banks, as lenders allowed substantial discounts on loan rates in a bid to out-price competitors. This resulted in unfair, discriminatory treatment towards smaller companies, who ended up shelling out much more in terms of interest. But with the new norms kicking in next month, such practices will be mostly muted.