Banks opting for short term loans

Banks in view of uncertainty conditions on interest rates and competition, are lending for the short term and are also introducing interest rate reset clauses to as early as three months.

At present there is low credit demand therefore companies are getting into practice of getting a loan sanctioned from big banks such as State Bank of India, and using this to strike for better deal from another bank, mainly smaller public sector and private banks. Due to this the major banks have decided to give short-term loans.

A senior executive with a public sector bank pointed out, “The ticket size is small because there is little demand for the loans for capital expenditure. So, there is little choice but to give short-term loans or put in other clauses”.

Normally banks reset interest rates after a year, but now they are working on the option of as early as three months, although in some cases the review of the rate is done after six or nine months, the executive director of a mid-sized public sector bank informed.

In the recent months up to August 15, 2009 there has been drop in the credit demand moreover in the same period last year the growth rate has declined to 15 per cent from nearly 25 per cent.

Simultaneously, banks are full with liquidity but have less option of lending as the Reserve Bank of India (RBI) is offering only 3.25 per cent under the reverse repo window which banks used to draw out excess liquidity.

Up till now on a regular basis, since the last five months, banks have been investing over Rs 1,00,000 crore with RBI.

It was also expected that the record government borrowing, accounting at Rs 4,51,000 crore for the current financial year, is going to put pressure on the corporate sector’s fund-raising plans, on the other hand companies have not been lining up capital expenditure because they have surplus capacity. Due to which the interest rates have remained soft.

Further with inflation expected to rise due to a low base effect and a rise in commodity prices, interest rates are expected to get harden. Bankers are expecting RBI to reverse its soft rate regime favoritism as soon as the growth picks up. “Bankers are unable to assess when the bias would change and therefore they are resorting to these methods,” a senior executive at a European financial services major informed.

Another bank executive stated, “There will be a problem if the reset clause is invoked only after two or three years. It is better for the banks to have the set clause every three or six months. Resets should take place more quickly as interest rates will harden in six to nine months”.

Another banker pointed out 80 to 85 per cent of his bank’s lending is linked to the benchmark prime lending rate (BPLR). In case there is increase in BPLR the interest rate on a loan will also go up. However the government is insisting on ensuring a low rate regime, thus banks are not keen in using BPLR as the only benchmark.