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Don't throw out the PLR yet

Subir Roy | September 24, 2003

The Reserve Bank of India has laid down a fairly stiff timetable for the Indian Banks Association to come back with its plan for banks to determine and disclose their benchmark prime lending rates, that is the basic underlying prime lending rates on the basis of which all lending rates are calculated.

This is because the matter has been hanging fire since April when the regulator first expressed its desire for such a rate and with every passing day the announced PLRs are becoming more and more meaningless.

Quite simply, as banks keep lending at sub-PLR rates, the PLR has become a contradiction in terms -- it is no longer the rate at which banks lend to their prime customers.

If the PLR has become a dinosaur, why is the RBI trying to give it a new lease of life by seeking to reform it? Why not let it slowly become extinct? Or why not simply let the banks do what they like with their PLRs?

The PLR could indeed be given a decent burial but there are related issues of disclosure, fair play and customer protection, which would still need to be answered.

The big and healthy companies now no longer need bank loans and this is likely to be the case in the foreseeable future. The banks would therefore need to tailor their ways of working to meet the needs of those who are likely to remain their main customers?

Small and medium enterprises, agricultural and retail borrowers. By their very nature, these do not have the same resources as large corporates in terms of both access to market information and ability to shop around.

So the main customers of banks in the foreseeable future will suffer from an asymmetry of information and size vis--vis their bankers.

One could say to these: tough luck, take it or leave it. But the regulator cannot do this because for the good of the economy, you need banks to keep financing these sectors.

Smooth and balanced economic growth, the sort that reduces poverty, cannot take place unless bank or bank-like institutions give loans at affordable rates to these sections, which do not have the means to go shopping around for the best deals.

The International Monetary Fund is today accused of having administered to Latin America through the eighties, a medicine worse than the disease, thus making it live through a decade of lost growth.

It tried to rectify structural imbalances by curbing runaway inflation through reining in money supply.

It thus created tight liquidity conditions, which prevented banks from financing even the working capital requirements of SMEs. This led to loss of output, growth and incomes.

In India, the non-urban sector suffers from a severe lack of adequate credit delivery. Moneylenders in rural areas are still able to get away with charging usurious rates as they are the only source of credit to large sections of the rural population.

Small farmers and farm workers are unable to get funds for their farming operations or important personal needs at commercial but affordable rates because of the failure, for different reasons, of commercial and cooperative banks to deliver.

Thus, the main issue is that ordinary individuals in both urban and rural areas and all companies except perhaps the top 200 and exceptionally healthy ones down the line need bank finance and a level playing field where banks cannot take them for a ride.

Today, many small companies read about low interest rates only in the papers. Reductions in PLR keep getting announced but do not touch these companies.

One way of solving this problem would be to have a benchmark PLR and a regulatory requirement for banks to load their risk and tenure premium on it and give a borrower in writing that his rate is X per cent plus PLR.

Then the borrower can go to the branch and demand a rate change for himself when he sees the bank making a corporate announcement of a PLR change.

There is also the case of individuals taking housing loans on a floating rate basis but finding that there is no mechanism whereby he can get the benefit of a change in the benchmark rate.

A lot of the travails of small borrowers result from the attitude of the staff in bank branches, which is quite independent of the banks' corporate mindset.

Typically, branch staff are often reluctant to pass on to customers what is due to them out of either a concern for branch profitability or simple cussedness. Degrees of this transcend the public-private-foreign divide in the banking industry.

If the PLR cannot be reformed then by all means, let it be buried, but the system has to simultaneously come up with a remedy for the ills outlined above.

Some of the practices which hurt the small customer really fall in the domain of fair trade practices and should be addressed by machinery set up to ensure them, rather than the banking regulator. (The latter need confine itself to ensuring improving levels of accounting disclosure.)

The problem is that such machinery hardly exists as it is still early days for consumer protection in India. There are bank ombudsmen but they cannot involve themselves with such routine matters as ensuring that customers get the right rates.

In this situation, transparency and rationality in the practice of fixing, announcing and implementing PLRs can be one way of protecting banks' small customers who are now becoming their main customers.

It is not advisable to throw out the PLR unless we have something better to replace it with. Till then it should be reformed and made to deliver better.

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