INDIA BUSINESS WORLD - OCTOBER 2005
THE MONTH THAT WAS

LOANS ABOVE 5 YEARS TO COME AT 8.5%

Seven public sector banks and a financial institution, with a sizeable share in the corporate loan market, have decided not to undercut each other. It's an informal understanding to raise and maintain a higher interest on loans.

The move comes close on the heels of RBI doing a quarterpoint hike in the reverse repo rate-a short-term interest rate at which the central bank takes money from banks.

The senior managements of these banks recently met to decide that term loans with tenure of five years and little less will be sanctioned at around 8%, while loans above five-year period will carry an interest of about 8.5%. These loans were earlier sanctioned at competitive rates of 7% and even 6.75%.

Given the presence of foreign banks and aggressive private players, it's not clear how a cartel of sorts would work in the industry. More so, with corporates having multiple avenues to raise funds. The collective decision by a clutch of banks may also be driven by the higher provisioning imposed by RBI. The new provisioning will squeeze the net interest margin for banks. Besides, RBI has made it clear that the practice by banks to give loans at rates well below the benchmark prime rate is opaque and unacceptable.

Corporate circles familiar with the development said that they may not have a way out, since there is no market beyond five years for external commercial borrowings. However, a chief financial officer from a leading corporate house thinks that the move to hike lending rates by banks may be justified. "The yield on the government the five-year government bond is 6.5%," he said.Bankers know that corporates will think twice before further stepping up their dollar liabilities, amid a rising dollar and hardening Libor rates, currently at 4.5% for six months. The forward premium which a domestic borrower will have to pay to hedge against the rising dollar will offset the benefits of a lower interest rate abroad.