Banks protect margins,fix floor rates

Set Rates For Sub-PLR Loans, Try To Hedge Risks In A Falling Rate Scenario

Sangita Mehta MUMBAI

    BIG banks are playing it safe in a volatile market. In a bid to protect their margins — the difference between lending and deposit rates — lenders are fixing a floor on loans disbursed below their benchmark prime lending rates even as top-rated corporate borrowers continue to demand lower interest rates.
    Multiple banking sources said lenders such as the State Bank of India, Indian Overseas Bank, IDBI Bank, Corporation Bank, Union Bank of India and Punjab National Bank have begun fixing floor rates on loans below PLR on a case-tocase basis. "While in the past there were very few instances of banks fixing a floor rate on loans, it is happening more frequently now," a senior executive at a public sector bank said.
    Fixing a floor below PLR ensures that each time the benchmark rate is revised downwards in a falling interest rate scenario, the lending rate does not have to be lowered concomitantly. Banks also fear that they may not be in a position to trim deposit rates sharply from current levels. While most banks are certain that interest rates are bound to fall further in coming months, they are not sure how steep the fall would be.
    For instance, if a bank's PLR is 12.5% and a corporate manages to negotiate a loan at two percentage points below the PLR, the bank's margin shrinks each time the PLR is revised downwards. However, if a floor is fixed at 9%, no matter how steeply the PLR falls, the corporate will have to pay 9%. In such a scenario, a floor will also work as a hedge in a falling interest rate scenario. While most banks are placing a floor on advances for long-gestation projects such as road and ports, other banks said they have placed a floor rate while giving loans to real estate companies, non-bank finance companies and the small and medium enterprise segment.
    In an attempt to spur lending, along with a reduction in key policy rates, the Reserve Bank of India has since September last year progressively cut the cash reserve ratio — the non-interest bearing portion of deposits that banks have to park with it — leading to an infusion of cash into the system and a demand for lower rates.
    Banks pointed out that when interest rates fell steeply in 2004, some banks had agreed to charge a fixed rate as low as 7% on a three-year loan. They had suffered heavily when the interest rate cycle changed in 2005.