The Reserve Bank of India's September proposal to ask banks to move to the marginal cost method to calculate their base rates has left some banks jittery. Bankers say the move, on which detailed guidelines from the central bank are expected soon, will impact institutions with greater exposure to fixed tenure loans and impact profitability.
The base rate is a rate set by a bank below which it cannot lend. Banks currently use a number of methods to calculate their base rates, such as using their average, blended or marginal cost of funding.
But amid a perception that banks have of late been slow in lowering their base rates in response to the central bank's decision to lower its key repo rate, the RBI came out with the proposal suggesting banks move to the marginal cost benchmark. Under this, banks will have to use the latest interest rate payable on current and savings accounts (CASA) and term deposits of various maturities as one of the key variables in calculation.
In an interview with CNBC-TV18, VG Kannan, Managing Director of country's largest public-sector lender State Bank of India, said the RBI should allow for a more calibrated move towards shifting to the new method instead of asking banks to move immediately.
"Also, I hope the Reserve Bank, before announcing the policy, back tests its decision to assess how the base rates rise in a rising interest rate environment," he said.
Kannan said banks that have low CASA deposits will stand to be impacted more from the shift, seeing an overall impact of anywhere between 10 to 25 basis points on the net interest margin (NIM). Deposits, along with market borrowing, are the chief sources of funding for banks.
Banking analyst Parag Jariwala of Religare Capital Markets agreed with Kannan's views on the margin impact, and said PSU banks such as SBI, Bank of Baroda and Punjab National Bank -- which have higher exposure to corporate loan book -- will be impacted.Below is the transcript of the interview on CNBC-TV18.Latha: Are you privy to what the Reserve Bank of India (RBI) might suggest in terms of the new calculation of base rates?Kannan: I wish I had been the privy to this. We only have the last guideline, which was given by the RBI. Subsequently, we had a couple of discussions with it where we suggested slightly alternate ways of doing it. As you mentioned, in a scenario when the interest rate is coming down, we expect base rates to also come down, which has been the case.However, directly linking it only to the marginal cost immediately would have a very damaging effect. So, while we are not saying that it should not be done, it should be done in a calibrated way. We have suggested certain different methodology of calculating marginal cost. Let us hope that Reserve Bank of India is in a position to see it and examine what are the very simple implications. As regards to the marginal cost, an issue is: what will happen when interest rates start going up? I only hope that the Reserve Bank, before it announces the new policy, also back tests the same to try to find out whether in the last four-five years, what would have been the base rates had this been implemented and what would actually be the scenario the rate starts going up. So, that is something which we are constantly have been advising Reserve Bank of India, I hope that they take cognisance of this particular aspect.Sonia: You did say that if banks move to marginal cost of funding it would be a damaging impact. What could the impact be for banks such as yourselves that have a higher floating rate loans? How much could the impact be on the net interest margins you think?Kannan: The exact numbers will be difficult to say because we really don’t know what is going to be the formula. However, based on the current formula, the impact will be substantially lower. To some extent, we can also mitigate it by charging a higher spread but then the entire purpose of the base rate being bought down would be defeated.It would be anywhere between 10-25 basis points, it could be a much bigger leap for banks which are having low cost of deposits in form of current-account-saving-account (CASA) deposits. However, banks which are having lower CASA may not be that much impacted because their base rate would have been calculated on different basis.Latha: Can you tell us the difference? If the base rate is calculated on the basis of what the RBI had put out as draft guidelines that is the marginal cost is the input what will be the impact on your net interest margins (NIMs) and if it in on the basis of what you said a synthetic mix of half the cost being marginal cost and half of it being average cost then what is the impact? Kannan: There are two-three formulas, which we have suggested. One is: we suggested that you consider about 40 percent of our deposit base as interest rate agnostic while the remaining 60 percent is interest rate variable. In case we take only some portion of the deposits, which are maturing say in next three months and then that is re-priced on the basis of the new rates. Then the impact will be much lower because a substantial portion of the deposits which are going to mature beyond the 90 days, it should be around 70 percent or 80 percent of the remaining deposit could be something at the old rate -- in which case the impact could be much lower. In the event the entire amount is going to be re-priced at the new card rates, then the impact on NIMs will be much higher, maybe even 20-25 basis points. We are bit not too sure as to what is going to be the formula. If they go with our method, I think it will be slightly more received by the banking system and that they may look at it. Having said that Reserve Bank of India has also been talking about developing [method for converting] floating-to-fixed and fixed-to-floating but in the absence of a derivative market, which is not even a percentage of the total deposit in the system, how this will pan out is a question mark.Latha: From the guidelines that are already available which are the banks that you would think are most affected?Jariwala: I agree with Mr Kannan that the guys who have a very high proportion of corporate loan book and very reasonable proportion of CASA, they are the largest one who will get impacted. Largely, all PSU banks mainly State Bank of India (SBI), Bank of Baroda (BOB) and Punjab National Bank (PNB) they are the one who are largely exposed more to corporate loan book. If the draft guidelines get adopted, then I think the margin impact could be anywhere between 15-25 basis points across PSU banks.Sonia: Since Parag Jariwala was talking about the corporate loan book, demand continues to be extremely muted over there. Have you seen any signs of a pick up at all and what do you think the loan growth could be by the end of the year?Kannan: This is a question which we have been answering regularly for last three-four months. The new corporate loan book has not been growing in a big way. We are seeing some green shoots in the form of some of the renewable energies coming up. Small expansions are going on but nothing very large ticket business are coming up. There are some good corporate which have already seen the date of commencement of commercial operations (DCCO) taking place which are going for re-financing as low risk because most of the implementation risk has been done. Otherwise from the entire system, the credit off take is relatively muted. We expect that even if there is a robust growth in the next three months the maximum about 12-13 percent would be the maximum credit growth we expect for the financial year ending 2016.Latha: How many companies do you think you can wrest ownership through the strategic debt restructuring (SDR) before the financial year is out? Do you think Electrosteel Steels is I believe at mature stage? They have just announced to the exchange that the annual general meeting (AGM) is underway to convert lenders debt into equity and give them 51 percent equity. Should we see a handful of cases where new promoters would come in?Kannan: There are indications of a new promoters coming in because some of the plants which are going into SDR including the name which you mentioned as far as the plant quality is concerned it is supposed to be very good. Only problem is maybe the working capital as also the equity infusion and some new promoter has also some existing participants in the market have shown some interest in acquiring this because it becomes an expansion at much lower cost in lowest implementation period. If there is a somebody there in the position to put into the operation it will be a win-win for all including the bankers, the country at large because having invested so much of a money into the particular project, if the project goes down completely it is a waste for the country. From that point it is a big positive. Yes, it is going to be a test case and if one or two succeed there will be a spate of more cases, which will come up and it will also show the interest which the international player will have in Indian markets.
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