Investments in infrastructure in the eleventh five year plan are estimated at Rs 2.056,150 crores ($ 514 billion) and the avenues to raise them are limited.
According to the Planning Commission Report on projections of Investment in Infrastructure (August 2008) it is estimated that only 30 percent of the infrastructure needs can be met directly from the budget.
While 40 percent of the requirements are expected to be met from internal generation and market borrowings, the remaining 30 percent have to come from private investment and this depends upon the creation of a supportive investor friendly environment and the ability to roll out bankable projects.
Finding these resources is the challenge faced by the economy to achieve 9 to 10 percent growth in GDP by 2012.
This calls for an innovative approach to policies. Efforts are on to mobilize funds by offering tax incentives. The Government has allowed some institutions like Life Insurance Corporation of India, Industrial Finance Corporation of India, Infrastructure Development Finance Corporation and some non banking finance companies authorized by the Reserve Bank as infrastructure Companies to issue tax free Infrastructure Bonds to raise funds. Can these institutions raise the required funds ?
Time has come for banks to restructure their balance sheets and find ways and means to support infrastructure development in a big way. Although banks have been in infrastructure financing, the tendency to avoid long term funding of infrastructure projects citing short term nature of resources and consequent asset- liability mismatch has been there since late 1990s with the introduction of asset liability and risk management concepts. Minimization of cost and maximization of profit without locking up of funds in long term ventures has been the philosophy pursued and the reforms in regulation and supervisory areas also are well suited to follow this line of approach. No doubt it has paid huge dividends and our banking system has proved to be sound and safe. But can this approach go on?
The Financial Institutions catering to long term needs of industries also found the circumstances conducive to convert themselves as banks and we have ICICI and IDBI banks in the place of ICICI and IDBI which were prominently and successfully engaged in financing huge long term projects for decades. Only institution which remained and continues to function as an All India Financial Institution is only the Industrial Finance Corporation of India Ltd. Some institutions like Infrastructure Development Finance Corporation, Infrastructure Leasing and Finance Ltd , etc, have since been developed but they are not adequate enough to meet the ever growing demands of infrastructural developments in tune with the international standards and requirements of the economy slated to register double digit growth.
Reliable Source
Banking System is the best and reliable source for infrastructure funds. With branches spread all over the country and abroad and with knowledge of the people and markets banks can easily mobilize the resources.
However, there is need for policy, regulatory support and incentives without in any way compromising on banks’ safety and soundness.
The banks should be allowed to mobilize funds for a minimum period of five years and a maximum period of ten years and these funds have to be shown under the nomenclature “Deposit for infrastructure development”.
The funds should be exempt from CRR / SLR and their investments should be allowed comparatively to carry a lower risk weight for capital adequacy.
Though the exemption from CRR will have an adverse impact to contain particularly the defying inflation but the benefits that can accrue to the economy in terms of GDP growth and economy’s international reputation and image with improved physical infrastructure. The interest earned on these deposits up to Rs 20,000 can be considered for tax exemption . The rate of interest can be more or less equal to that of post office savings interest for Fixed Deposits with tax benefits.
To Counter Asset- Liability mismatch, the approach has to be something different as far as these funds are concerned. Since the maturity pattern is definite i.e. only after five years and more, the deployment of funds will also be beyond five years and above. Mismatch may even then arise but with enough head room for adjustment.
Banks will have adequate time and opportunities to bridge the mismatch. The periodical cash flows from investments have to be recycled in such a way that they minimize the mismatch.
The take out finance which did not take off as envisaged needs to be revived to encourage infrastructure financing by banks and specialized institutions.
Securitization of infrastructural advances and development of secondary market for these papers will also go a long way in finding the liquidity for banks and minimizing the adverse impact of mismatch. It is for authorities to come out with the right environment.
Dr.T.V.Gopalakrishnan
Former Chief General Manager,
Reserve Bank of India
( views are Personal)
( This appeared in Business Line dt 26/07/10).
Monday, July 26, 2010
Sunday, July 11, 2010
Is base rate sustainable?
Is Base Rate sustainable?
The Prime Lending Rate introduced early in 1990s and refined as Bench Mark Prime Lending rate (BPLR) in 2003 as a reference rate by the banking system has been given a go bye and in its place the Base Rate has been brought in effective from July 1, 2010.
What difference the Base rate makes to borrower customers and the banking system and how this rate will help the Reserve bank to transmit its monetary policy signals can be assessed or understood only after the rate stabilizes over a period of time?
Basically, the BPLR and the Base rate should reflect the cost of funds ,the risk margin, and the rate of return to the bank but the difference lies exactly in arriving at the cost of funds and the transparency in its computation and application. The computation of base rate is expected to be on a uniform basis and apparently leaves no scope for manipulation. It takes into account the cost of deposits, the operating costs, the negative carry on cost in the maintenance of statutory requirements i.e. Cash Reserve Ratio and Statutory Liquidity Requirements, risk and profit margin.
BPLR and Base Rate
Compared to BPLR, which was basically computed on historical basis, the base rate has to be assessed more on a futuristic basis. The base rate will vary from bank to bank and in a way it should reflect on bank’s efficiency in bringing down the cost of funds and dynamism in the overall management of funds. Unlike in the case of BPLR, the banks cannot lend funds below the base rate except in certain permitted categories of lending under Differential rate of interest schemes, advances against fixed deposits and agricultural advances having subvention from the Government and export credit. This is a major change and will be a challenge for banks to retain major corporate clients as borrowers as hitherto. This should also bring in some changes in the money market operations as some of the borrowers may switch over to short term instruments like commercial paper to raise funds at lower rates than the base rate.
Various banks have announced their base rates and they range between 7.5 percent and 8.5 percent. How they have arrived at the base rates, however, have not been made transparent . The rates are also much higher than the one year FD rates, call money rates, Bank Rate, repo rate, and the yield on Government bonds. They are also reflective of the generally high cost of the funds. The compulsion to maintain the NET Interest Margin at around 3 to 3.5 percent also seems to have influenced banks in fixing the Base rate comparatively at a higher level.
Struggle to maintain customers
Will the banks be able to realistically assess the Base rate reflecting both the past and future trends and will the rate be able to transmit the Reserve Bank’s monetary policy signals effectively are the major doubts lingering in the minds of knowledgeable public?
Although the base rate may come down in the long run, immediately the large borrowers particularly good borrowers who had enjoyed banking funds at less than the BPLR will have to shell out more towards interest as they cannot borrow at less than the base rate. This may naturally lead them to resort to some other means to raise funds or banks will be compelled to compensate them to retain as their customers which is not desirable.
They may go in for Commercial papers or external commercial borrowings or raise deposits from public directly at less than the base rate. In any case this will have an adverse impact on banks’ funds management and profitability. In such a situation, banks will be forced to entertain comparatively risky borrowers adding to their non performing loans and consequent problems.
Good Timing
Although, the concept of Base rate is good to establish healthy credit market and improve banks’ asset liability management down the years , it may in the immediate future upset the corporates’ borrowing programmes and bring some visible changes in the money market operations. In case the base rate stabilizes, it may also pave way to develop corporate Bond market in a big way. Present surplus liquidity situation in the economy and continued persistence of higher level of inflation, however, supports a higher base rate and from that angle the timing of introduction of base rate seems well intended and justifiable.
Dr.T.V.Gopalakrishnan
(This appeared in Business Line Dt July 12,2010).
The Prime Lending Rate introduced early in 1990s and refined as Bench Mark Prime Lending rate (BPLR) in 2003 as a reference rate by the banking system has been given a go bye and in its place the Base Rate has been brought in effective from July 1, 2010.
What difference the Base rate makes to borrower customers and the banking system and how this rate will help the Reserve bank to transmit its monetary policy signals can be assessed or understood only after the rate stabilizes over a period of time?
Basically, the BPLR and the Base rate should reflect the cost of funds ,the risk margin, and the rate of return to the bank but the difference lies exactly in arriving at the cost of funds and the transparency in its computation and application. The computation of base rate is expected to be on a uniform basis and apparently leaves no scope for manipulation. It takes into account the cost of deposits, the operating costs, the negative carry on cost in the maintenance of statutory requirements i.e. Cash Reserve Ratio and Statutory Liquidity Requirements, risk and profit margin.
BPLR and Base Rate
Compared to BPLR, which was basically computed on historical basis, the base rate has to be assessed more on a futuristic basis. The base rate will vary from bank to bank and in a way it should reflect on bank’s efficiency in bringing down the cost of funds and dynamism in the overall management of funds. Unlike in the case of BPLR, the banks cannot lend funds below the base rate except in certain permitted categories of lending under Differential rate of interest schemes, advances against fixed deposits and agricultural advances having subvention from the Government and export credit. This is a major change and will be a challenge for banks to retain major corporate clients as borrowers as hitherto. This should also bring in some changes in the money market operations as some of the borrowers may switch over to short term instruments like commercial paper to raise funds at lower rates than the base rate.
Various banks have announced their base rates and they range between 7.5 percent and 8.5 percent. How they have arrived at the base rates, however, have not been made transparent . The rates are also much higher than the one year FD rates, call money rates, Bank Rate, repo rate, and the yield on Government bonds. They are also reflective of the generally high cost of the funds. The compulsion to maintain the NET Interest Margin at around 3 to 3.5 percent also seems to have influenced banks in fixing the Base rate comparatively at a higher level.
Struggle to maintain customers
Will the banks be able to realistically assess the Base rate reflecting both the past and future trends and will the rate be able to transmit the Reserve Bank’s monetary policy signals effectively are the major doubts lingering in the minds of knowledgeable public?
Although the base rate may come down in the long run, immediately the large borrowers particularly good borrowers who had enjoyed banking funds at less than the BPLR will have to shell out more towards interest as they cannot borrow at less than the base rate. This may naturally lead them to resort to some other means to raise funds or banks will be compelled to compensate them to retain as their customers which is not desirable.
They may go in for Commercial papers or external commercial borrowings or raise deposits from public directly at less than the base rate. In any case this will have an adverse impact on banks’ funds management and profitability. In such a situation, banks will be forced to entertain comparatively risky borrowers adding to their non performing loans and consequent problems.
Good Timing
Although, the concept of Base rate is good to establish healthy credit market and improve banks’ asset liability management down the years , it may in the immediate future upset the corporates’ borrowing programmes and bring some visible changes in the money market operations. In case the base rate stabilizes, it may also pave way to develop corporate Bond market in a big way. Present surplus liquidity situation in the economy and continued persistence of higher level of inflation, however, supports a higher base rate and from that angle the timing of introduction of base rate seems well intended and justifiable.
Dr.T.V.Gopalakrishnan
(This appeared in Business Line Dt July 12,2010).
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