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Large borrowers call the tune

The recent mid-year review of the credit policy has focussed on one of the glaring deficiencies of the banking system in the reform era. It was known for a while that banks, especially public sector banks, have been either unwilling or unable to price a substantial portion of their loans in a rational manner and in line with their cost of funds. Both the concept and the reliance on prime lending rates (PLRs) have been relatively new in this country. When first introduced, PLRs, a mechanism by which individual banks determine the interest rate structure, served only a notional purpose. All categories of interest rates were administered. Each bank could determine its own PLR — basically its weighted cost of funds plus a reasonable spread — but such an exercise, which was also meant to impart a measure of transparency, had only an internal reference. With the freeing of most types of interest rates in the reform era, the situation changed completely. Banks automatically acquired the discretion to charge their customers on their own assessment of risks involved. The PLR, as it evolved in the developed countries, has been the rate applicable to their best customers. In India, however, as reforms gathered pace from the 1990s, banks had also to reckon with increasing competition not only from among themselves but also from the rest of the financial sector. Determining PLRs has been the easy part. Far more difficult has been basing their loan rates on them. It is reported that a substantial portion of bank loans to corporate customers — the figure mentioned is as high as 70 per cent — has been at sub-PLR rates.

This is a serious imbalance that the recent review seeks to correct by asking the Indian Banks Association to formulate fresh guidelines on the calculation of PLRs in a scientific manner. Banks will continue to have the discretion to charge sub-PLR rates but hopefully such decisions would be transparent and justifiable, on the basis of overall business connections, for instance. The problem that banks face is that they are dictated to by those companies who have an ever-increasing number of other options to raise funds. Consequently, banks are forced to levy higher rates on loans to small industries and agriculture, two sectors that rely more than ever on bank funds. Evidently, banks' practice of favouring corporates with loans at very attractive rates has had its repercussions on their liabilities too and depositors have been getting a raw deal. Deposit rates in many instances do not cover inflation. Such an invidious practice of subsidising one class of borrowers while penalising the socially important sectors as well as the depositors has to end. There is far too much at stake for the economy as a whole. Public sector banks, especially, need to regain their once acclaimed pioneering skills on lending to small businesses and agriculture even in a much more competitive era. For them most corporate loans are "safe". Individual managers who continue to remain risk averse need to be motivated through more enlightened personnel policies.

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