The practice by commercial banks of charging differentiated interest rates from borrowers based on their credit ratings has made corporates with moderate to low investment-grade ratings to call for rationalisation of rates that are now ‘5 to 6 percentage points higher than those offered to top-rated companies.’
They say the high interest costs, which are as high as raw material costs, have made their businesses unviable and they will not be able to compete besides as well as failing to make any tangible contribution to Atma Nirbhar Bharat in the post COVID-19 period.
Calling for a reduction in the gap, they said while the government has been encouraging banks to lend to spur growth, such high rates would force them out of business following margin erosion.
“In principle, this may appear logical, but in practice, the difference is so huge that no company can make money and will continue to be in a high-cost debt trap,” said a corporate borrower.
“While credit rating is important, in any case, collaterals and other securities are taken while disbursing loans. Hence, banks must be more considerate,” he said.
According to borrowers, if in case of retail loans and investment-grade U.S. dollar bonds, the differential is 0.5% to 1% and in some cases 2%, then, then the same yardstick could be applied to corporate loans. “High interest rates have consistently eroded the competitiveness of Indian products; it fuels inflation,” said Essar Ports MD and CEO Rajiv Agarwal.
“It increases risk and reduces the leverage, thus making default imminent and debt servicing difficult.”
“Infrastructure funding cannot sustain double-digit interest and capital-intensive projects can never get high rating due to high debt service and are thus prone to failure. It’s a vicious cycle, therefore interest rates need to be capped for industry.We have suffered rates in the range of 12 to 15% for infrastructure projects,” he added.
“Bankers end up complying with guidelines using credit rating as an academic assessment measure for creditworthiness but start-ups do not have a track record, leading to low credit ratings,” said Mohnish Wadhwa, founder, Wadhwa & Shah. “Hence, there is a need to set up standards by the banking regulator to evaluate an underlying idea from a debt perspective,” he said.
He said with lack of debt exposure due to inadequate credit rating, start-ups dilute equity at a cheaper valuation with private equity. Asserting that banks lend depositors’ money and cannot value each client at the same level, Vishal Rathi, partner, S.K. Patodia and Associates said “a corporate that has a good credit score should get the benefit and in case a corporate improves on the rating later, they can seek revision in the rates.”
“This practice is helping banks to cover their risk.” Higher rate of interest is for covering the risk which bank is taking to fund the low credit rating customer,” he added.
Backing the banks, Krishnan Sitaraman, senior director, Crisil Ratings, said the world over, this had been an accepted practice. “It is a classic example of linking risk with returns. A borrower whose credit profile is weaker is more risky from a default perspective, and to compensate for that, the lender charges a higher interest rate,” said Mr. Sitaraman.
He said linking lending rates to credit profiles of borrowers was conceptually aimed at addressing the credit risk in lending business. “Lenders link lending rate premiums to not only cover default risk but also expectations of post default recovery,” he said adding corporate credit risk assessment approaches were often different from those in retail credit risk because of fundamental differences in how these risks manifest themselves.
“In corporate loans, because of higher ticket sizes, a default by one or few loans can have a much larger impact on bank balance sheets and it is helpful if each of these loans are assessed in a great amount of detail. In retail loans on the other hand, these are of lower ticket sizes and here the benefits of diversity and granularity kick in. So portfolio based credit risk assessment lends itself very well to such loans. Because of these differences, pricing models towards corporate loans and retail loans may vary,” he said.
Karthik Srinivasan, Group Head, Financial Sector Ratings, ICRA said, “banks, like other lending institutions are commercial organisations. While we do not have a true risk-based pricing in the Indian debt market, it is quite logical that the lending rates will increase as the borrower profile get weaker.”
“The extent of the increase in rates will also depend on the banks historic experience with that entity or sector and the collateral offered while factoring the market landscape at that point in time. A well-developed bond market with diversified investor base would certainly help rates relatively benign while also providing lenders with adequate risk adjusted return,” he added.
Last year, the RBI mandated banks to have their new sanctions linked to external benchmarks. In a falling interest rate scenario, the move helps borrowers based on their interest reset terms but may turn the other way once the rate cycle reverses, Mr Srinivasan added.