Banks' strategy tilts towards bonds, commercial paper

By Gayathri Nayak

MUMBAI: Even as banks are waiting for viable projects to come up to lend, there is a quiet shift in their strategy in favour of investments in instruments such as commercial paper and bonds, facilitating borrowings by companies at rates lower than that it would cost on bank loans.
Bank executives cited weak demand for credit and central bank restrictions on the interest rates they can charge on loans as the reasons driving their new preference for the corporate debt market. They expect a shift back to the core business of lending when the market turns around.

In the April-June quarter, loans to industry including to large corporates and small businesses dropped Rs 83,880 crore, or 3.1%, while overall bank credit rose Rs 6,330 crore, or 0.1%. Bank investments in commercial paper increased 8.2% to Rs 6,680 crore during the period, while that in bonds rose about 11%.

For top-rated companies, this means the cost of funds could be as low as 7%, compared with interest rates of 9% and higher that banks levy on loans.

“Banks are opting for commercial paper and bonds in the absence of credit demand. Investing in top-rated corporates lowers capital costs for the banks (though returns may be low),“ said VK Kathuria, executive director of Union Bank of India. “Over the long run, there could be a shift towards bonds and commercial paper as the corporate bond market develops. The bond market may grow at a faster pace than credit, though on a small base.“

The Reserve Bank sees better transmission of policy rate through such non-lending channels. “The good thing about monetary policy as governor (Jeremy) Stein of Federal Reserve said, is it gets into every crack. What we see today is, transmission is not happening as much through banks as through money market rates. Those money market rates feed into rates at which they issue commercial paper,“ RBI governor Raghuram Rajan had said when asked about weak transmission of interest rates in banking.

At end of June, `3.3 lakh crore of commercial paper was outstanding in the market, with banks holding about a quarter of that.

Bank treasury officials said the restrictions on lending rate, created by RBI benchmarks, which is linked to cost of funds, also played a part in the shift. “We have an artificial barrier which restricts lending at rate below that threshold,“ said Jayesh Mehta, country treasurer of Bank of America-Merrill Lynch. “There is no such restriction when it comes to investment in bonds or commercial paper. At some point, this barrier will have to go allowing banks to lend at a rate they are comfortable at.“