The proposed regime for computing base rate, the benchmark for pricing loans, might burn a big hole in the bottom line of banks in the next financial year.
Banks might take a one-time hit of Rs 20,000 crore or Rs 200 billion to follow the Reserve Bank of India (RBI)’s prescription to use marginal cost of funding to decide base rate, according to CRISIL.
However, there is benefit in store for borrowers, as the base rate would be lower by 50 basis points (bps) under the new norms, said ratings agency CRISIL in a statement.
RBI’s draft guidelines on computation of base rate, if implemented in its current form, will significantly impact the profitability of banks.
The guidelines require banks to follow the “marginal cost of funds” method for base rate computation from April 1, 2016.
Banks currently have the flexibility to compute rate on average cost of funds or marginal costs.
Voicing concerns over its adverse impact, senior public sector bank executives said the balance sheets are under severe pressure due to low growth and high credit costs.
The loan book is linked to floating rate, as high as 80 per cent in some cases for some banks, while 60 per cent of liabilities (deposits) are at fixed rate.
The credit costs — amounts set aside for bad loans — will continue to remain high, as banks are saddled with high share of stressed loans.
Plus, the visibility of improvement in the credit off-take remains low.
The stressed advances — gross non-performing assets plus standard restructured assets — stood at 11.7 per cent of total advances of banks in March 2015, according to RBI data.
Pawan Agrawal, chief analytical officer, CRISIL Ratings, said the change in methodology would reduce banking sector profitability because return on assets will fall by 20 bps in FY17.
In the base-case scenario, profitability of banks will have one-time impact of around Rs 20,000 crore or Rs 200 billion in FY17.
It would be equal to 15 per cent of the total estimated profit of the banking system for that year.
The actual impact will depend on whether the banks will be given leeway to make this shift over a longer time frame in the final guidelines.
Further, for every subsequent 25 bps cut in the deposit rate, profits will be impacted by Rs 5,000 crore in a year from the rate cut.
Given a sliding interest rate cycle, the effect might be magnified for banks with high share of corporate credit. Foreign brokerage firm Nomura, in impact report, said the marginal cost of funding will likely lead to unnecessary volatility in margins/profitability of banks and hence this new methodology should not be enforced on banks.
“If implemented though, in the current rate scenario, it will be negative for banks, especially corporate banks, as the rate cycle looks downwards over the next two years,” Nomura said.
Yields of banks that lend mostly on a floating rate basis will be significantly impacted in an environment of falling interest rates.
Banks with low levels of current and saving accounts, and/or relatively longer tenure term deposits, will also be majorly affected, said Rajat Bahl, director- Financial Sector Ratings at CRISIL. Nevertheless, in an increasing interest rate scenario, banks will tend to benefit.
They will be able to immediately pass on any hike in deposit rate to the base rate. RBI has proposed the changes to ensure faster monetary transmission.
The new calculus for the base rate will increase the sensitivity of bank lending rates to changes in the RBI’s policy rate.
However, given the impact on profitability, banks might shy away from cutting deposit rates, especially in times of low profitability, which will defeat the objective of quick transmission of cuts in the RBI’s policy rates.
