>BANKS (MERRILL LYNCH)

■ RBI’s new draft proposal to streamline PLRs: The RBI has put out a draft proposal (for consideration) recommending that banks should create a “base rate” to substitute the PLR (prime lending rate) to ensure greater transparency in fixing of lending rates. The base rate would be benchmarked to a banks’ retail deposit costs adjusted for the impact of SLR and CRR, minimum overhead costs and average ROE. Further, banks’ would not be allowed to provide less than15% of loans “below the base rate”. Few categories of loans (like credit card receivables, loans to bank employees’ etc have been excluded).

■ Linkage between lending and deposit rates more visible: In our view, the proposed recommendations would force a strong linkage with deposit rates and enhance transparency in loan pricing and help reduce the proportion of sub-PLR (est. at 67% as per RBI) lending as PLRs had become redundant. Further, it should help remove the “stickiness” in loan rates when deposit rates are cut. It would, however, push up rates of many AAA rated borrowers that were getting loans at much below PLR, given the cap of 15% for loans “below base rate”.

Base rate to substitute PLR:
More transparency in pricing

■ NIM impact minimal post “base rate” (8.5-10%): We don’t expect bank margins’ to be materially impacted (assuming proposal is implemented) post re-alignment in rates in key sectors / low rate loans. The effective “base rate” is likely to be around 8.5-10% for many banks. While substantially below many banks’ current PLR, it is in sync with the prevailing rates. Moreover, banks lending rates will also price in the operating costs, credit risk premium and tenor premium. Hence, spreads could easily be +400bps over the base rate for many SME segments. No cap on spreads. Educational loan is a segment where banks’ lending rates may be lowered by 1.5-2%; but corporate loans at 7%. Export rate not impacted. Further, ‘floating rate loans’ (like mortgages) banks’ can use external benchmarks (besides base rate), if required.

■ Impact on earnings not significant: In our view, the proposals, if accepted, are likely to be implemented only by early CY10. Hence, impact on Fy10 earnings should be minimal – even if we see some shift in borrowers to mutual funds (near term). Impact on FY11 earnings too may be limited owing to limited impact on margins. Further, with credit picking up and rates bottoming out, the shift to other sources may get reduced and banks may actually get more leverage with borrowers enjoying very low rates!

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