By drafting norms to modify the loan system for large borrowers only, is the Central bank trying to be a helicopter parent again? Smaller accounts, too, are culprits. The RBI must look for a more practical and effective way of financial discipline
In December, the Reserve Bank of India (RBI) came up with a notification requiring banks to mandatorily convert at least 40 per cent of the sanctioned amount for accounts having fund-based working capital limits of Rs 150 crore or more to a working capital loan, with effect from April 1, 2019. As per this, the loan limit will be revised to 60 per cent, with effect from July 1, 2019. It was introduced with a view to instill greater credit discipline among borrowers.
As per RBI data, by the end of June 2018, the number of accounts having credit limits exceeding Rs 100 crore stood at around 12,000. The total amount of credit outstanding between them was around Rs 26 trillion, indicating an average amount outstanding of over Rs 200 crore per account. It is important to understand the problem the RBI is trying to solve through this regulation. Firms can seek working capital limits far exceeding their requirements, thereby shifting their liquidity risk to the lending banks. Cash credit lines involve a commitment of cash on demand on the bank and allow firms to dip into this bucket as needed. Banks, therefore, are forced to invest much of these committed funds into liquid assets at low interest rates and incur an opportunity cost. Besides, since interest is charged on actual use rather than the committed amount, this facility allows firms to hedge their cost of borrowing as well.
Another problem that can arise when banks sanction limits that exceed firms’ genuine requirements is the possibility of diversion of working capital funds to finance long-term assets or towards completely non-business uses. This increases the probability of default and these disbursements turning into NPAs. So the problems that the RBI is seeking to address are genuine and serious. But can this regulation really address the issue or is the RBI barking up a wrong tree?
RBI data show that 83 per cent of the accounts having more than Rs 100 crore of working capital limits are in the sub-12 per cent interest rate range and account for 85 per cent of the total outstanding credit of this category, indicating that majority of large accounts are good credits. Of course, this assumes reliable credit ratings by the CRAs and interest rates on working capital facilities to be good indicators of financial health.
Second, the average utilisation rate of cash credit limits across the banking sector is 66 per cent with the 6-12 per cent interest rate accounts utilising anywhere between 65-75 per cent of their limits. This is based on average of balances as at the end of five quarters — June 2017 to June 2018. Utilisation of less than 40 per cent is seen among the riskier accounts attracting higher than 17 per cent rate of interest with varying pattern across bank categories. This simply means that the intersection between large accounts and those with low utilisation is close to negligible. So how will mandating large accounts having limits of Rs 150 crore and higher to convert at least 40 per cent of their limits to a working capital loan solve the problem of low utilisation? For most of the accounts, it will simply convert the existing cash credit utilisation to a working capital loan, at probably the same rate of interest.
Accounts with low utilisation of less than 40 per cent constitute less than one per cent of the total number of all Private Sector Banks fund-based working capital accounts as well as limits sanctioned and belong to the 17 per cent plus interest rate categories. In the case of PSBs, such accounts comprise close to 50 per cent of all accounts and about seven per cent of the limits and belong to the 20 per cent plus rate of interest category. Nearly 80 per cent accounts of foreign banks holding 16 per cent of limits sanctioned show poor utilisation and belong to the 17 per cent plus groups.
These accounts are ripe cases for mis-utilisation of funds and future NPAs. As they comprise a very small percentage of the total limits sanctioned across the banking system, they do not pose a systemic risk but default in these accounts might have significant impact for the individual banks.
While PSBs seem to have been more prudent with their overall limits portfolio, they run a concentration risk — the sanctioned limit per account is highest in the 16-18 per cent interest rate category, besides the sub six per cent category. The private sector and foreign banks though, have awarded largest limits to their better clients, attracting sub 10 per cent interest rates. This increases the impact of a probable default in these PSB accounts while the diversified portfolio of private sector and foreign banks in the risky category might be a saviour except in an economy-wide crisis.
Nearly all the 17 per cent plus interest rate accounts belong to the Rs 10 lakh and below categories, ie MSMEs. These accounts comprise 76 per cent of all working capital credit outstanding. The greater than Rs 100 crore accounts are negligible in this interest rate bracket — they are less than 250 in number with an average exposure of Rs 75 crore. Their total amount outstanding accounts for nine per cent of the banking system’s, definitely not an insignificant proportion from a default risk perspective. So is the RBI regulation meant for these 250 to 300 accounts? Shouldn’t there be a more practical and probably effective solution for individual banks to simply identify these accounts and discipline them? Besides, this regulation will do nothing to rein in the smaller accounts discussed earlier that are also culprits in this problem.
Another risk of implementing this regulation is adverse selection leading to the possibility of misuse of funds to become a reality. Good accounts are either already utilising more than 60 per cent of their limits or will not mind reducing their fund limits as they are confident of getting them enhanced when the need arises. It is the riskier accounts that would not like to let go of a sanctioned limit in hand and if 40 per cent of it has to be mandatorily drawn down, these funds are very likely to make their way into long-term assets funding, risky financial assets, or worse, completely diverted out of the business. By using a cannon to kill a few flies, albeit poisonous ones, the regulation may just encourage the type of behaviour it is trying to prevent.
(The writer is Assistant Professor, Accounting & Finance, MDI, Gurgaon)