Banks linking loans to gilts

Banks are now benchmarking loans against the yield on government securities following the recent bout of volatility in the bond market.

"Government securities-linked loans are slowly becoming popular now. Some large telecom, power and infrastructure companies have opted in for it. The new benchmark is being adopted for long term loans," said a general manager in charge of credit with a public sector bank.

For infrastructure projects, banks prefer to link the interest rate to the yield on government security since this would mean the rate would move up with every rise in the volatile government securities market.

From the start of this fiscal, the yield on the 10-year benchmark gilt has moved up close to 70 basis points to close at 6.50 per cent yesterday. It shot up as much as 150 basis points a month ago. (One basis point is 1/100th of a percentage.)

The government securities-linked loan typically has a tenor varying from 1 year to as much as 12 years.

The interest rate is reset once a year or once in 2-3 years.

The interest rate is benchmarked with the yield of the government security of corresponding tenor.

AAA-rated corporates can avail of a one-year gilt-linked loan at 100 to 200 basis points spread over the prevailing yield on the one-year government security.

The gilt-linked and sub-prime lending rate loans are the order of the day as the concept of linking loans to prime lending rates has become obsolete. The corporate loan market is fiercely competitive with even large banks such as State Bank of India losing business by as little as one basis point.

The margins on the corporate side are wafer thin and banks are falling over each other to lend to clients.

In the short-term segment, the popular products are the Mumbai inter-bank offered rate (Mibor) and commerical paper-linked loans. The loans are given to top corporates to adjust their daily cash flows with a put-and-call option.

The rates on the loans are reset everyday in line with the ruling Mibor/CP rates.

The Mibor-related loans market is very active with an estimated size of around Rs 15,000-20,000 crore.