Some banks provide long-term loans below bond market rates, SBI warns
The intervention of the Reserve Bank of India in the foreign exchange market and other measures have created so much liquidity in the system that some banks extend long-term loans to legal persons below bond market rates, even the Repo rates – which is unsustainable – the State Bank of India’s Economic Research Unit (SBI) has warned.
Declaring the matter as a “particular conundrum,” State Bank of India (SBI) group chief economic adviser Soumya Kanti Ghosh wrote in his report that even some 15-year bank loans were made at a negative spread of 60 to 70 basis points. on corporate bonds with an equivalent rating.
Part of the reason is that top-rated companies bid for competitive prices to meet their lending needs, and banks bid. Struggling with enormous liquidity and no ability to lend, banks are outbidding each other to offer rates below bond market rates.
“This type of irrational pricing, due to the abundance of liquidity, can impact the profits of the banking sector and initiate a mismatch between assets and liabilities, if the spread is more widespread for less well-off borrowers. rated, a sure recipe for financial instability in the future, ”Ghosh wrote.
Ghosh also pointed to reports that even AA-rated borrowers (below the highest-rated AAA rating) received loans indexed to repo rates at an interest rate close to 6%. “This indicates that lenders could engage in an undervaluation of risk; any adverse movement in interest rates could impact bank profitability and hard-earned financial stability,” Ghosh said.
Analysts agree, saying some large public sector banks and private banks engage in the practice.
Ultra-low rates have prompted companies to raise funds in the bond market. Short-term rates, in particular, are raised below the current repo rate of 4%. But long-term bond rates have also fallen considerably. For example, Nabard this week valued a 15-year bond at a half-yearly coupon of 6.59. The IRFC has priced a 20-year bond at 6.85% per annum.
“Investors will certainly suffer mark-to-market losses over the life of these bonds,” said a bond arranger. This is because rates will not stay that low in the years to come and if market yields increase, investors in these bonds should value the bonds with the going rates and suffer a loss.
According to SBI Research, the average excess liquidity so far this calendar year has been 4.15 trillion rupees, and the purchase of dollars by RBI has contributed to that liquidity. While the RBI intervenes in the forex market to contain excessive volatility, the continued intervention makes the job of the central bank more difficult. In the current fiscal year through September, the RBI made $ 43.6 billion in net dollar purchases and has accumulated $ 93 billion in foreign exchange reserves so far. This is close to the record buildup of $ 110 billion in 2007-08. These dollar purchases this year contribute more to liquidity. But the market is positioning itself for a possible stronger rupee as portfolio flows remain strong at $ 18 billion so far this year.
As a result, “on the whole, traders’ dollar supply is much higher than demand as they anticipate a stronger rupee and therefore might keep a short dollar position.”
Other economists agree that there is a limit to the amount of reserves the RBI can accumulate. Ultimately, the dollars will have to be deployed in low-yielding treasury assets, which lowers the RBI’s interest income. In addition, a stronger rupee also lowers imported inflation. The SBI does not expect inflation to drop below 5% until March of next year.
Therefore, the consensus among economists is that at some point the central bank would stop intervening in the rupee and let it appreciate. However, most forex markets do not expect a precipitous appreciation in the near term. The rupee closed at 74.01 per dollar on Wednesday, from its previous close of around 73.90 per dollar, following the correction in local stocks.