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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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