RBI proposal for loan pricing from ICICI Securities Ltd

The Reserve Bank of India (RBI) has proposed a draft circular suggesting that all loans be priced off a base rate by April 1, '10 as against benchmark prime lending rate (BPLR) at present. While this aims at increasing transparency in loan pricing and will lead to banks becoming more rational in pricing loans, we believe it will create discrepancies in pricing by different banks, given that base rate is likely to be a function of each bank's cost of funds and operating efficiencies – Banks with higher CASA ratios (and resultant lower cost of funds) and higher operating efficiencies are likely to benefit by this proposal.

• Base rate to replace BPLR from April 1, '10. While each bank will ascertain its base rate individually, the key determinants would be: i) cost of deposits, ii) negative carry on CRR/SLR and iii) unallocable overhead costs for banks. Finally, to this, a profit margin will be added to arrive at the base rate. Lending rates to borrowers will encompass base rate in addition to a few specific charges for borrowers that include product specific costs, credit risk premium and tenor charges.
• Loan pricing is likely to be more rational at the margin. Given that base rate would now be the floor for pricing loans, banks will have to do away with sub-PLR lending. As the lending rates would have to take into account the overall deposit costs, a proportion of operating expenses as well as a return margin, determining pricing loans will be a more disciplined process; also, we expect the unhealthy competitive pressure (through mispricing of loans) to reduce going forward.
• Banks with high CASA to benefit; NBFCs' funding costs to rise. Given that base rate will be a function of the cost of deposits and operating efficiencies, banks with higher CASA and lower cost/assets will benefit as their base rate would be lower than industry average, thereby allowing them to earn higher spreads on their products. However, we believe that the new guidelines would hurt short-term borrowings by NBFCs as well as some corporates, as their current short-term borrowing rates would be lower than the base rate for most banks.
• We await clarity. Overall, while we believe that the base rate will increase transparency in loan pricing, we await some clarity from bankers as determining unallocable overhead costs could be a daunting task, especially for some PSUs. Also, as base rates could vary significantly for different banks, it could lead to considerable discrepancies in lending rates by different banks and render some banks as uncompetitive. We also await clarity on whether other income would be included while determining RoAs for base rate.

Source : Equity Bulls

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