As policy rates fall, private sector lenders hug their loan rates more

Public sector banks have been more proactive to adopt external benchmark for loan rates of late

Private sector banks have been more reluctant to pass on policy rate cut benefits than their public sector peers. Is it defiance or defence?

Perhaps it is more the latter, as a look at the weighted average lending rate (WALR) for both groups of banks goes to show.

Cast your eyes on the adjoining chart.

WALR on outstanding rupee loans of private sector lenders rose by 16 basis points between February and July, when policy rates were slashed by 50 basis points. WALR on such loans for public sector banks rose by 3 basis points. A basis point is one-hundredth of a percentage point.

Outstanding rupee loans represent old loans and, therefore, also represents, to a great extent, those beleaguered corporates who are suffering from overleverage, and had defaulted on their repayments. Surely, they do not deserve a discount on their loan rates because the credit risk associated with them has gone up.

When it comes to pricing of risk, private sector banks have fared far better than public sector ones, even though both lent to the same set of corporate borrowers in many cases.

If we go further back over a longer period to the asset quality review of the Reserve Bank of India (RBI) in August 2015 as a starting point, the trend supports that private sector lenders are savvier in assessing risks. The review laid bare the fact that Indian banks were hiding troubled loans under the carpet of forbearance.

Since the asset quality review, WALR on outstanding rupee loans for private sector banks has dropped by only 74 basis points in response to a 100 basis point fall in RBI’s policy rates. For public sector banks, the fall was 141 basis points.

Of course, policy rates did not follow a singular path, but have also been raised at intermittent times since 2015. Nevertheless, in sum, private sector lenders have kept their loan rates from falling sharply, which indicates that they are not comfortable with the risk profile of their borrowers.

That said, lenders such as State Bank of India (SBI) and other public sector banks have been proactive in adopting the external benchmark method to price loans, while their private sector peers have been not so forthcoming. Now that the use of external benchmarks for retail and small business loan rates is mandatory, all lenders will have to fall in line by October.

“The external benchmarked products are likely to be introduced in the next quarter and we need to see their relative pricing as compared to MCLR, which is high today but converging,” analysts at Kotak Securities Ltd wrote in a note. MCLR stands for marginal cost of funds based lending rate.

It would be interesting to see how private sector banks continue to price risk, while adopting an external benchmark for loan rates.