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Draft Base Rate Guidelines Credit Negative For Banks: Moody's

By Religare

International rating agency Moody's said the Reserve Bank's draft guidelines for base rate computation are credit negative for banks as they will reduce their loan-pricing flexibility, said the media reports.

Draft Base Rate Guidelines Credit Negative For Banks: Moody's

Last week, the RBI issued draft guidelines on adopting marginal costs-of-funds methodology in the computation of base rates and a standardised set of spreads in determining lending rates. They would be effective from April 1, 2016.

"This standardisation in methodology is credit negative because it will further reduce the banks' loan-pricing flexibility by tying them to a base rate that is lower in an environment of declining policy rates," the rating agency said as per the PTI report.

According to Crisil, another rating agency, if the guidelines for base rate computation are implemented in the current form, it could have a one-time impact of around Rs 20,000 crore on the banks' profitability in FY17.

Banks' base rates are a function of cost-of-funds, negative carry on the cash reserve ratio and statutory liquidity ratio, unallocated overhead costs and average return on net worth.

To determine the cost of funds, banks currently have the freedom to base calculations on other methods (average cost of funds, blended cost of funds) which produce a higher rate than the marginal cost-of-funds method in the current environment of declining policy rates.

"Banks not already using the marginal cost-of-funds methodology will be most affected," the Moody's report said.

The rating agency said as the latest interest rate on various deposits will be used for calculation of marginal cost of funds, banks with a greater proportion of term deposits in their funding base would likely be most affected.

"... Because longer tenor deposits are less sensitive to decreases in policy rates, they tend to increase the cost of funds derived using current calculation methods," it said.

Besides base rate, the RBI will also require banks to adopt a standardised set of spreads which the Indian Banks' Association will decide.


"With the introduction of new guidelines, this change will reduce banks' flexibility in determining their lending rates," the report said.

Although the guidelines will allow for more efficient policy rate transmissions by forcing banks to set lending rates more aligned to current interest-rate conditions, Moody's expects the RBI's increased micro-management to negatively pressurise banks' interest margins and profitability, particularly in the current benign credit environment.

Read more about: moodys
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