Uncertainty on interest rates and competition among banks are forcing lenders to lend for the short term and introduce interest rate reset clauses that kick in as early as three months.
At a time when credit demand is low, companies are resorting to the practice of getting a loan sanctioned from larger players, such as State Bank of India, and using it to negotiate a better deal from another bank, especially smaller public sector and private banks. As a result, the larger players have started opting for short-term loans.
"The ticket size is small because there is little demand for the loans for capital expenditure. So, there is little choice but to give short-term loans or put in other clauses," said a senior executive with a public sector bank.
Banks typically reset interest rates after a year, but are now exercising the option as early as three months, though in some cases the review of the rate takes place after six or nine months, the executive director of a mid-sized public sector bank said.
In recent months, credit demand has dropped and for the year up to August 15, 2009, the growth rate has fallen to 15 per cent from around 25 per cent in the same period last year.
At the same time, banks are flush with liquidity and have little choice but to lend since the Reserve Bank of India offers only 3.25 per cent under the reverse repo window used to draw out excess liquidity.
Yet, on a regular basis, for the last five months, banks have been parking over Rs 1,00,000 crore (Rs 1,000 billion) with RBI.
Although record government borrowing, budgeted at Rs 4,51,000 crore (Rs 4,510 billion) for the current financial year, was expected to put pressure on the corporate sector's fund-raising plans, companies have not been lining up capital expenditure because they have surplus capacity. As a result, interest rates have remained soft.
Going forward, with inflation expected to rise owing to a low base effect and a rise in commodity prices, interest rates could harden. Bankers expect RBI to reverse its soft rate regime bias once growth picks up. "Bankers are unable to assess when the bias would change and therefore they are resorting to these methods," said a senior executive at a European financial services major.
"There will be a problem if the reset clause is invoked only after two or three years. It is better for the banks to have the set clause every three or six months. Resets should take place more quickly as interest rates will harden in six to nine months," added another bank executive.
Another banker said 80 to 85 per cent of his bank's lending was linked to the benchmark prime lending rate. So, if the BPLR went up the interest rate on a loan would go up. But with the government insisting on ensuring a low rate regime, banks are not keen to use BPLR as the only benchmark.
