Short-term corporate loans under lens

The practice of banks providing unsecured short-term loans to corporates at low interest rates in place of working capital loans has come under the Reserve Bank of India (RBI) scanner.

Corporates have struck short-term loan deals with banks to reduce the interest costs, as the rates charged on working capital loans have risen sharply. Working capital loans are normally contracted above the prime lending rates (PLRs) and are also secured against the assets of the borrowers.

Banking sources said the RBI has asked banks to furnish information on short-term unsecured loans disbursed at rates below the prime lending rates (PLRs), after realising that such low cost lending was replacing working capital loans. The RBI is concerned about a deterioration in the quality of the banks' loan assets and lax monitoring of the end-use.

Corporates have a structured arrangement with banks to avail working capital for their day-to-day requirements. This is long-term engagement and depends on the extent of drawals. The banks provide working capital finance through a consortium, when the requirement is large.

With the hardening of interest rates, the cost of funds availed through the working capital window has also gone up. Corporates thus prefer to negotiate short-term loans which entail lower interest rates.

The RBI is apprehensive that some banks, driven by their zest to increase portfolio sizes, have extended short-term loans without adequate due diligence on the end use. The central bank is also worried that lax monitoring and absence of collateral could lead to a decline in asset quality during tough times.

The banks argue that they go by the reputation of the corporate clients when providing short-term finance and do not feel the necessity to examine the end-use of funds as long as the clients repay regularly.

A bank official admitted, "while payments from corporates are regular currently, the scenario could change in times of difficulties."

Since the banks do not have any securities to fall back on to ensure recovery of outstanding dues, the risk of non-performing assets would increase, another private bank official said.