Banks take tough line with India Inc

Meet next week to discuss armtwisting by firms.

Banks are planning to take a united stand and stop lending to corporates at below the average cost of funds. The country's largest commercial bank, State Bank of India, has taken the initiative to put an end to arm-twisting by corporate India to raise money at dirt cheap rates from the banking system.

Top public sector bankers will meet next week to chalk out a plan in this regard. The message will be simple: Banks will no longer encourage corporates to shop for loans by playing one bank against another. On agenda are two crucial issues "" project financing at short-term rates and lending at below the average cost of funds.

"We could do so when there was ample liquidity in the system. With the tightening of liquidity, we cannot afford to lend at unreasonably cheap rates to our corporate clients. We plan to formulate guidelines which can be followed by all players," said a source close to the development. He refused to call it "cartelisation" as the meeting will not set any loan rates but lay down norms to protect banks' shrinking margins in face of intense competition.

In the first half of financial year 2006, banks have enhanced their credit portfolio aggressively but that has not translated into substantially higher interest income as they have not been able to push the loan rates up. Liquidity will tighten further in December with the outflow of over Rs 30,000 crore from the system on account of redemption of India Millennium Bonds of the SBI.

Overnight call rates have risen and the Reserve Bank of India has started infusing money into the system through its repurchase (repo) window to ease the strain on liquidity.

"Typically, for a 12-year project, a corporation raises money for the first year from one bank and goes to another bank in the second year to get an even better rate. Nowhere in the world a company can raise money for project financing at working capital rates. This practice cannot continue," said another banker.

"Some of us have been doing so to garner a larger share of credit. But this may turn suicidal in the long-run," added the source.

PSU banks roughly control three-fourths of the banking industry. If they decide to enter into a "no-competition" agreement among themselves, corporate India's honeymoon with low rates will certainly be over as private banks do not have the capital to support the huge credit demand of industry. The proposed meeting also justifies the RBI's concerns over the lack of transparency in arriving at banks' prime lending rates.

BANKING TOUGH

Who called the meeting?
State Bank of India

Who will attend the meeting?
PSU bank chiefs

What's on the agenda?
Stop long-term lending at short-term rates; don't give loans at below cost of funds

What's the hurry in doing so?
Banks are feeling the pinch as liquidity tightens and margins are under pressure

What will happen if they chalk out new norms?
Corporates cannot auction loans any more; honeymoon with cheap money will be over