SBI to scrap annual interest rate reset clause on loans

MUMBAI: The State Bank of India, which shocked investors with a 99% plunge in quarterly earnings , will scrap the annual interest rate reset clause on all loans and move to uniform base rate-linked payments to smoothen out the fluctuations in its profitability.

"Most term loans have one-year reset clause, which I think is cumbersome both for the company as well as for the bank," SBI chairman Pratip Chaudhuri told ET. "So, from now on, we will give term loans which will be linked to our base rate," the floor rate below which it won't lend to anyone. Banks' profitability gets squeezed whenever there is a movement in interest rates as borrowers are charged with a lag effect, while deposit rates rise immediately.

Most term loans have a one-year reset clause where the borrower's rate rises, or falls, at a pre-specified date even if the benchmark rates change. This leads to banks losing out when deposit rates rise, and benefits when deposits fall. The net interest margin, a measure of profitability fluctuates because of this reset clause.

"Having a reset every year suppresses our returns... it leads to uncertainty for corporates," Mr Chaudhuri said.

The State Bank of India will give all loans linked to its base rate, now at 9.25%. The benefits of the move could not be quantified. Corporates looking at long-tenure loan often bargain for a term loan where interest rate is fixed for at least one year.

In the past, SBI burnt its fingers after the central bank raised interest rates since it had committed to give borrowers a fixed rate loan at lower rates. "So we will make the process simpler and I think that will have impact on our yield on advances," said Mr Chaudhuri.

Also, the country's largest lender has decided not to compromise on margins to retain clients. "If any company at any point thinks that our loan has become expensive, we will give them a prepayment option," he said. Even for retail home loans, SBI has decided not to charge its customers for prepayment of loan, even if the customer is switching over to another bank.

Mr Chaudhuri, who took charge after a five-year reign by Om Prakash Bhatt, says the bank will focus on long-tenure loans. "I am a strong advocate of longtenure loans. They fetch higher returns," he says.

SBI's net interest margin was 3.32% for 2010-11. In an interview with ET last month, Mr Chaudhuri said he was confident that the margins would improve in the coming quarters.

"The net interest margin (NIM) is the core of banking and I see it coming back. We have readjusted our lending rates on May 10, wherein we will get better compensation. It is a slightly upward moving interest rate cycle, in which loans gets impacted first and deposits get repriced with a lag," he said. SBI has raised lending rate by 100 basis points since February.

Source: EconomicTimes