Base rate introduction unlikely to pressurise bank profitability, says Crisil

CRISIL Ratings believes that introduction of the base rate mechanism in India’s banking system, with effect from July 1, 2010, will enhance competition in the short-term lending space. Issuance volumes in the debt capital markets are also likely to increase as the highly rated corporates begin to shift towards these markets. Banks with competitive base rates and efficient treasury operations are well placed to benefit from the new scenario. However, competitive pressures are unlikely to impact the overall profitability of the banking system materially. The base rate system is also expected to enable banks to respond more efficiently to monetary policy measures.

CRISIL Ratings expects a change in the competitive landscape for short-term corporate lending, following the implementation of the base rate mechanism. The new mechanism will limit banks’ flexibility to provide finer rates. Says Pawan Agrawal, Director, CRISIL Ratings, “We believe that the highly rated corporates availing short-term loans (estimated at 7 to 10 per cent of total corporate loans) will look to transit to the more attractive debt capital markets (through short-term instruments), and choose banks with lower base rates.”

The base rate for public sector banks is in the range of 7.5 per cent to 8.25 per cent, while that for private sector and foreign banks is lower — by 50-100 basis points (bps). CRISIL Ratings believes that the large private sector banks with more competitive base rates are, therefore, now relatively better placed to garner market share in the short-term corporate lending space. However, public sector banks with superior treasury operations can partially offset competitive pressures in the short-term lending segment by subscribing to the debt market issuances of corporates.

In the long-term lending space, however, a material shift in market share is unlikely: CRISIL Ratings believes that the banks will set lending rates that are near the current levels. However, corporates with strong credit risk profiles and high ratings will be better placed than other players to negotiate rates with the banks. “Ratings may become strong differentiators for corporates over the near to medium term”, adds Mr. Agrawal.

Despite the expected increase in competition in the short-term lending space, implementation of the base rate system is unlikely to have a significant impact on banks’ interest spreads. Says Suman Chowdhury, Head, CRISIL Ratings “Banks have flexibility to control other loan-pricing elements, including tenor and credit risk premiums, and product-specific operating costs. This will provide the banks with some cushion to protect their interest spreads.”

According to a recently published report from CRISIL Research, the average yield on bank advances is expected to decline by 10-15 bps over the next two years. Other conclusions of the report are that the base rate system will require banks to be more transparent in their loan pricing methodology, that borrowers with healthy credit profiles will now negotiate for finer pricing, and that SME and retail borrowers, who constitute a significant share of outstanding bank advances (at around 33 per cent), will be the biggest beneficiaries of the new system.

(This is press release of crisil)


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