Free Of The Stranglehold

TAKING a leaf out of the trend-setting Union Budget 1997-98, the Reserve Bank of India slack season credit policy last week announced sweeping monetary reforms and freed banks from almost all lending controls. At one deft stroke, it cut and freed the bank rate, made the credit delivery system more flexible and transparent, opened up foreign exchange markets and helped channel Rs 3,500 crore into the bourses. Admired Lester Pereira, director (treasury), Barclays Bank: "But for the political instability, Chidambaram and Rangarajan together have swept away all the major restraints for the Indian economy." Industrialist Rahul Bajaj agreed: "The policy will promote exports and improve liquidity in the market."

The credit policy, announced twice a year in April and October, lays out the guidelines for banks to function while maintaining price stability and integrating the various markets in government securities, money and foreign exchange. Since most transactions are routed through banks, policy changes affect every citizen directly or indirectly. Ideally, an increased liquidity should reduce the interest rates for corporates who borrow from banks to finance their activities. This lowers the cost of production, making the finished product cheaper to the average consumer.

While liquidity had improved after the busy season policy last October, the inflexible institutional mechanism did not allow banks to lend profitably. Admitted RBI governor C. Rangarajan: "A strong growth in bank deposits coupled with substantial reduction in cash reserve requirements had resulted in abundant liquidity in the system. However, the offtake of bank credit was subdued. While short-term money market rates moved down as a result of the easy liquidity conditions, lending rates, which are usually sticky, remained high during the first half of 1996-97, but softened later.

Power to the banks: The policy attacks the problem of bank credit on two fronts. A one percentage point cut in the lending rate--popularly the bank rate--has made credit more attractive to corporates. On the banks' side, the consortium funding stipulation for credit above Rs 50 crore has been withdrawn and multiple banking syndication permitted where the arrangement suits both borrower and the banks. Banks are now free to adopt their own formula to assess the credit risk of individual borrowers and formulate their own loan limits accordingly. Chuckled Rangarajan: "The MPBF (maximum permissible bank finance) will not be in caps any more."

In addition, banks are also allowed to invest five per cent of incremental deposits in ordinary corporate shares including PSUs. That may finally bring Rs 3,500 crore into the capital market, at five per cent of Rs 70,000 crore of incremental deposits of banks in 1996-97. A just cause for jubilation at the bourses, were it not for the political uncertainty at the Centre. However, sceptics argue that most of this money may actually go to meet loans against shares, now considered equity investment, rather than be channelled into the secondary market. The former surely is a safer bet for risk-averse banks.

Also, last year, banks showed a marked preference for debt despite the stipulation. This time, with the RBI exempting from the Five per cent limit bank investments in preference shares/debentures/bonds of private corporate bodies, the central bank has sent a strong signal to the debt market. The only check that remains is the prudential exposure limit of 25 per cent of net worth for a single corporate and 50 per cent for a single group. Last fiscal, investments by banks in bonds/debentures/corporate shares/commercial paper increased by as much as Rs 6,577 crore compared to a Rs 164 crore decline in the previous year.

A reference rate: Perhaps the most radical policy change has been to reactivate and free the bank rate. The RBI has been content to let it lie dormant for so long that experts had been clamouring for a change. By reducing it from 12 to 11 per cent and by pegging term deposit rates to it, the RBI has signalled an across-the board reduction in interest rates. For term deposits up to one year, the rate is bank rate minus 2 percentage points, bringing the effective term deposit rate of interest to 10 per cent for a year. in addition, Rangarajan said, "to enable this rate to emerge as the reference rate, a new general refinance facility will now be available to banks up to one per cent of the average aggregate deposits of last year" at the bank rate of 11 per cent for the first four weeks and at 12 per cent for the next four.

Says Pereira: "With the removal of reserve requirements on interbank borrowings, the interbank term debt market will also help set an interbank reference rate like LIBOR (London InterBank Offered Rate)." Adds forex consultant Jamal Mecklai: "The crucial step of lifting the CRR (and SLR) on interbank borrowings will enable immediate development of an interbank yield curve at least up to one year, and the concurrent evolution of a benchmark rupee interest rate which may end up as the Mumbai InterBank Offered Rate.

Forex maze cut: Concurrent with these, the foreign exchange markets have also been opened up and made more transparent and less complicated. Exporters holding an EEFC (Exchange Earners Foreign Currency) account are permitted to extend trade-related advances to their importer clients out of EEFC accounts up to $3 million per account. To help achieve greater integration between domestic and overseas money markets, dealers are now permitted to borrow up to $10 million from their overseas offices without any conditions on end use. They will also be allowed to invest up to the same amount abroad. Authorised dealers can offer rupee-forex currency swap between two corporates without approval. To impart flexibility to corporates and improve liquidity in the financial markets, dealers are also permitted to book forward cover for exporters and importers without any complicated documents.

Banks have responded warmly to the credit policy changes. Hours after the announcement of cut in CRR and SLR and of the refinance scheme, the prime lending rates (PLR) Started falling. Leading nationalised banks, the State Bank of India, Bank of Baroda, Bank of India, Corporation Rank, United Western Bank have all expressed their intent to cut PLR by one per cent.

No risk, no gain: Corporate chiefs and bankers unanimously welcomed the policy. Even smaller companies are happy with the withdrawal of consortium lending for working capital. Now companies can borrow from one bank which will syndicate the loan to other banks. This will also avoid the delay in fund disbursal. Says D.D. Rathi, vice-president finance, Indian Rayon & Industries: "The removal of consortium banking does away with an ancient, outdated practice. "

It is, however, anybody's guess how public sector banks will take to the abolition of MPBF. In a dissent note to the Kannan Committee suggestions, SBI had argued that public sector banks may not be ready for MPBF abolition. Said a senior bankman: "'The new environment may have empowered banks in a big way to take a lot of their own decisions, by moving from a system of micro supervision to prudential guidelines. But it is difficult to say how soon the banks will rise to the occasion and shed their inhibition to lend.

While everyone seems happy, analysts feel that the real credit offtake will begin only after the busy season credit policy. "And it will depend a lot on what shape the government takes and how much of these policies continue undisturbed by the new mandarins at the North Block," says an institutional broker. But the markets also acknowledge that the RBI's credit policy has more credibility and stability than the budget. Sums up a banker: "That RBI is performing with a market oriented autonomy is probably to the biggest credit of this policy." ·