India's peculiarity: Low bond yields, high lending rates

SBI and other large banks' minimum lending rate remains steady at 9.30 per cent since September last year

Benchmark bond yields are a good measure of gauging a country’s interest rate. Therefore, going by the 10-year bond yields and the recent cut-off of the new 10-year paper, it can be assumed that the medium term interest rate of the economy is around seven per cent. 

There is a reason to be happy about it, as low interest rate is a necessity for the economy to remain abuzz with activity. But, in India, the cheerleaders are still sitting on the sidelines. Banks are holding back their lending rates from falling and therefore, interest rates continue to remain more or less where it was a few quarters back. 

State Bank of India’s (SBI) and other large banks’ base rate, or the minimum lending rate, remains steady at 9.30 per cent since September last year. No customer can borrow from the bank below this rate, which was last cut in response to a sharper-than anticipated rate cut of 50 basis points by the Reserve Bank of India (RBI) and its sharp criticism to the lenders for not letting lending rates fall.  

Despite several high pitched criticism from former RBI  governor Raghuram Rajan, banks continue to be parsimonious with their lending rates, even as the bond market yields  fall responding to the policy.  No wonder, then, that the banks are losing their business to the bond market, as better rated firms swarm the market with their bond offerings, which are also bought by the banks as investments. 

Retail customers, and lower rated firms and a vast lot of small and medium enterprises dependent on bank loans —have no avenue to tap but look up to banks for their funding needs. Companies, in fact, have started tapping the corporate bond market from quite some time now, as banks refuse to expand their balance sheet, or lend at a cheaper rate. 

The report of the working group on ‘Development of Corporate Bond Market in India’, said total corporate bond issuance has increased by 236 per cent from Rs 1,74,781 crore in 2008-09 to Rs 4,13,879 crore in 2014-15. Similarly, the number of issuances has increased by almost 153 per cent from 1,042 in 2008-09 to 2,636 issuances in 2014- 15.

And, this number has increased substantially this year, said RBI’s annual report.  “In 2015-16, there was a surge in public issuances of corporate bonds,” RBI report released at the end of August said.

At present, the corporate bond market amounts to 31 per cent of total credit to the corporate sector in India, according to Moody’s estimates.  If RBI’s recent measures to deepen the bond market fructify, surely the share will increase, reducing bank loans to the segment. That should force banks to lower their lending rates to garner business. 

“When RBI hikes rates, it is not to directly curtail inflation, but to curb inflationary expectations. Similarly, bond yields are a signal and banks will have to respond,” said Ramkamal Samanta, vice-president, treasury at SBI DFHI Ltd. 

As the government has now freed up small savings rate, banks can now lower their deposit rates and that can eventually be reflected on the lower lending rates. 

“Now that banks also have liquidity support from the RBI, lowering rates could be just a matter of time. However, one has to keep in mind how long the bond yields itself remain low at a time when the US interest rate is expected to firm up,” Samanta said.  

Experts say big and well rated customers are now unlikely to head the banks’ way for loans, as the difference between lending rates and the bond yields will continue for a long time to come.  Ironically, it’s not only those who have to depend on banks for their loan, but banks themselves are losing out big time and are building up systemic risk for themselves.  

As bigger clients shift to the bond market route, banks are increasingly ending up with risky clients that cannot hope to raise money through the bond route for the possible junk rating they would garner if going for rating appraisals.  If banks are not careful, they are going to really put their depositors’ money in to a basket of lemons, say analysts, and that is again raising the prospect of asset quality stress that banks are still suffering from. Only this time, the entire bad debt will be banks’ own making and not necessarily the economic situation.  But, this is also what RBI wants. 

By limiting banks’ ability to lend beyond a level to highly leveraged companies, the central bank is making sure that the firms themselves tap the market and not overburden the banking system, especially in cases of long-gestation project loans. While  RBI has become impatient on banks not lowering the rates, it is also creating the environment for firms to shun banks for a large part of their credit requirement.

“The pricing points could prove to be instrumental for development of market segmentation. This differential pricing  is encouraging AAA or AA+ rated corporates to borrow at cheaper rate directly from markets, and savers to invest at higher rates in banks,” said Soumyajit Niyogi, associate director at India Ratings and Research.  

This is a conscious creation of an environment that is encouraging “higher leveraging to high rated borrowers and government to borrow at cheaper rates, but without inducing leveraging for individual,” Niyogi said.