Prime lending rate fast losing signal status

Home loans rates may have gone up, but banks seem to be in no hurry to hoist their benchmark prime lending rates (PLRs).

A month after the credit policy signalled a reversal of cheap money, the only bank to have pushed up its PLR is ICICI Bank, which raised it by 0.5 per cent to 10.5 per cent. None of its big rivals has followed suit.

There are two reasons why banks are hastening slowly. The minority view, espoused by a section of foreign and private banks, is that interest rates may actually start weakening if the short-term tightness in the money market - where banks borrow and lend to one another - eases off.

"Interest rates could come down, and we need to be ready for interest rates to go up and down," said Deepak Parekh, chairman Housing Development Finance Corporation (HDFC). If oil prices come down, HDFC may bring down its interest rates, he stated.

"Interest rates are more sensitive to short-term market rates than long-term ones," says a senior private sector bank official.

Rates in the inter-bank overnight money market had crossed 6 per cent last week, higher than the rate of 4.5-4.6 per cent before the credit policy was announced on October 24. It is only in the last couple of days that call rates have easened to around the repo rate of 4.75 per cent.

Majority of banks feel there is no need to raise PLR because it actually has little relevance to the borrower.

"We have no immediate plans to increase our PLR since it has no effect. A (big) chunk of our lending anyway takes place at sub-PLR rates," says O N Singh, chairman and managing director of Allahabad Bank.

What Singh seems to be saying is that PLR is not what the name implies it is. Traditionally, PLR is the rate at which banks lend money to their most creditworthy borrowers.

In the last few years of easy money and excessive lending caution, banks have actually given loans to their best customers at rates well below the PLR.

Says G V Nageswara Rao, managing director of IDBI Bank, "for a bank to revise its PLR, a lot depends on how much of its lending is (actually) at PLR."

At IDBI Bank, over 80 per cent of advances go to borrowers rated A and above by credit rating agencies, where the margin of safety for lenders is good.

An A rating signifies adequate safety, with Triple A being the highest rating, two notches above A. In the last few weeks, the rate at which top-notch corporates borrow funds from the banking sector has risen by 150 basis points.

When good borrowers can borrow below PLR, banks that charge more can lose business to competitors. Thus, Union Bank of India, which raised its home loan rates by 0.25-0.50 per cent after the credit policy, declined to tinker with its PLR of 10.75 per cent.

"Our PLR is already too high. If we raise the PLR now, we will end up losing market share," said a senior bank official.

While prime corporate borrowers are obviously able to get favourable rates, some banks are wary of raising rates in highly competitive segments such as home mortgages, where the Reserve Bank has raised capital requirements as a risk mitigation measure.

ABN Amro, for instance, does not intend to revise its rates despite the squeeze in margins. "Agreed, with the rise in risk weightage (for mortgages) we will lose margins, but the question is whether the market allows you to raise rates," says Ramesh Sobti, executive vice president and country representative, ABN Amro Bank N.V. (India).

Most bankers will, probably, look for cues from the State Bank of India (SBI), the country's largest, before moving ahead with a rate increase. SBI itself says that it will take a decision only after seeing which way wholesale price inflation (currently 7.76 per cent) and international oil prices (currently $48.9 a barrel for US light crude) move.

"At the moment we don't need to raise our benchmark PLR, but will do so if inflation and oil prices continue to move upwards," says a senior SBI official. SBI's PLR is at 10.25 per cent.

HDFC's Parekh shares his views, stating interest rates can fall if oil prices come down. Incidentally HDFC raised its PLR by 0.5 per cent to 10.25 per cent.

ICICI Bank may seem to be a lone ranger in the banking sector to increase its PLR. But even its move can be seen as a correction rather than a real increase. Reason: the actual PLR range of the five largest banks in the country covers a wide band between 10.25 per cent and 12 per cent.