RBI Policy: Is Easy Liquidity Leading To Mispricing Of Risk?

A large surplus of liquidity, alongside desire to grow loan books while keeping risk-taking to a minimum, could be leading to lending at rates which do not adequately compensate banks for the risk.

These concerns over mispricing were highlighted by State Bank of India Chairman Dinesh Khara at an event in November, in the presence of Reserve Bank of India Governor Shaktikanta Das.

"I will not say that the risk people have assumed without understanding. They have understood the risk and assumed the risk," Khara said, while seeking the regulator's outlook on liquidity. "But the mispricing seems to be one of the major challenges and, perhaps, it was the anxiety on the part of bankers to grow their book."

"The mere fact that there is excess liquidity should not lead to any mispricing of loans," responded Das, while adding that currently prevailing conditions are not going to be a permanent feature.

Liquidity has been in surplus since even before the Covid crisis hit. During the pandemic, the regulator eased liquidity further to ensure financial markets don't freeze up. The surplus was at nearly Rs 7 lakh crore as of Dec. 6, 2021. Including government cash balances, it's even higher.

While the RBI has stopped adding liquidity via bond purchases and forex intervention has slowed, the central bank has not taken any active measures to reduce the liquidity surplus.

Top Corporates Getting Too Sweet A Deal?

One segment where bankers fear mispricing is in loans given to top corporates.

Three officials in corporate lending departments of public and private banks say that, on average, lending rates and spreads for their large corporate clientele have been cut sharply, as compared to what prevailed before March 2020. This, bankers say, is a way to grow the corporate lending portfolio and earn slightly higher yields compared to parking the money at the RBI's reverse repo window.

According to the first of the three bankers cited earlier, the spreads charged by banks to well-rated wholesale borrowers have dropped to historic lows in the last few months. This is particularly true for short tenor loans but is also visible in longer-term lending.

For AAA-rated corporates, loans up to six months were being priced at 20-30 basis points above the reverse repo rate of 3.35% till around September, the first of the three bankers cited earlier said. This is significantly lower than the 70-75 bps spread over the repo rate that was charged to top rated borrowers before the Covid crisis.

Since the October policy, the cut-offs at the RBI's variable rate reverse repo window have risen to around 3.9-4%. This has meant that lending rates have risen a bit but the spread has remained the same, the bankers said.

Karthik Srinivasan, group head for financial sector ratings at ICRA Ltd., said with surplus liquidity and strong deposit growth, pricing issues may continue for some time.

"Some corporate borrowers might benefit from these lower lending rates, but then banks must take a strict look at the asset cover available, before they decide on pricing," Srinivasan said.

Otherwise we will end up with a new set of bankers repeating mistakes of the past.

Karthik Srinivasan, Group Head - Financial Sector Ratings, ICRA

Home Loan Rates: Low & Lower

Highly secured, long term retail products such as home loans are also inviting extremely fine pricing now, said the bankers cited earlier.

New home loan rates and loan transfer rates are ranging between 6.5-7% since September, for the top-rated borrowers. This implies a spread of 250-300 bps over the repo rate, which is usually the benchmark for such loans. In 2021, right before the festive season offers started, the spreads ranged between 280-400 bps for home loans, depending on the type of lender.

In this case, bankers are fearing a double whammy. The rush to give out home loans has meant a build-up of lending at relatively low spreads to borrowers who may not be able to withstand higher rates.

Home loans are now linked to an external benchmark, in most cases the repo rate. As such, when the repo rate is hiked, the equated monthly payment due will also rise unless the customer chooses to extend the tenure of the loan. This could lead to stress in the portfolio, which may not be adequately compensated for by the spreads being charged by banks.

However, the mispricing of risk here may be lower than in the case of large corporate lending.

"Home loans are seeing increased competition, but we believe that the spreads on offer reflect a structurally different quality of risk which has held up even through the pandemic," said Saswata Guha, senior director, Fitch Ratings India. He added that a bulk of the home loans are not being offered at the lowest card rates—which is offered in select cases (such as not exceeding a certain ticket size), and with specific conditions. "So the minimum home loan rate being offered by a bank does not necessarily imply a lower risk premium for the entire book."

Moreover, Guha says, home loans are only a portion of the overall of the home. Banks also consider the lower loss given default, quality of the borrower and asset, when deciding the risk premium.

We continue to believe that a very low lending rate scenario poses many risks to the system, but the risks in the retail book are comparatively lower.

Saswata Guha, Senior Director, Fitch Ratings India