Sub-PLR lending seen hitting spreads

REPORT ON TREND AND PROGRESS OF BANKING IN INDIA 2004-05

Over 60 per cent of banks' total outstanding advances above Rs 2 lakh were at rates below prime lending rates (PLRs) of banks.

Many players' average lending rates are below their PLRs, which is exerting more pressure on their spreads, the Reserve Bank of India (RBI) said in its report on trend and progress of banking in India in 2004-05.

The banking sector's term loans outstanding as on March 31, 2005 totalled Rs 6,24,534 crore. While deposit rates of banks have declined from 13 per cent in 1995-96 to about 5 per cent in 2004-05, the average lending rates declined from 17 per cent to approximately 10 per cent during the same period. As a result, the spread between the deposit and lending rates has widened by almost one percentage point.

Downward flexibility of PLR emerged in the recent past as a significant policy issue for the RBI, especially with respect to credit delivery to small and medium borrowers, at reasonable costs. 
 

UNDER PRESSURE Movements of Prime Lending Rates
(In per cent)	Mar'03	Mar'04	Mar'05	Sept'05
Public sector banks	9.00-12.25	10.25-11.50	10.25-11.25	10.25-11.25
Private sector banks	7.00-15.50	10.50-13.00	11.00-13.50	11.00-13.50
Foreign banks	6.75-17.50	11.00-14.85	10.00-14.50	10.00-14.50

This draws attention to the fact that although sub-PLR lending had enabled corporates to raise funds at competitive rates from banks without incurring any additional cost towards stamp duty, dematerialisation costs or fee payments to issuing/paying agents, yet it has distorted the role of the BPLR.

The growing perception has it that on one hand, there is under-pricing of credit risk to large private companies. On the other hand, there could also be an over-pricing of risk in loans extended to agricultural and to SMEs.

As a solution, the central bank suggested, it is merit-worthy to review current procedures and processes of credit pricing. This could be done via a well-structured, segmented cost-analysis at different stages of intermediation in the complete credit cycle.

Also, there is a need to bring about an improvement in risk assessment and risk management systems in banks. The continuing reduction in non-performing asset levels and interest expenditure should pave the way for banks to set lending rates on a more realistic basis, RBI said.

The BPLR was introduced to bestow larger transparency in pricing of bank credit. However, with sub-PLR lending, the spreads between minimum and maximum lending rates have risen in a significant manner, the RBI explained.