Published On : Thu, Jan 14th, 2016

Rajan warning coming true? Bond mkt slowly eating banks’ lunch

In August last year, RBI governor Raghuram Rajan had said that even if banks were slow in passing on the reduction in rates to customers, money markets (another name for bond markets) were reflecting the true cost of funds in the system. His indirect warning to the banks may now be ringing true. Already beset with bad loans and competition from payment banks, a new source of trouble appears to be emerging in the form of bond markets.

By not reducing rates quickly enough for whatever reasons, banks may have ceded ground to bond markets as an alternative for corporate borrowers. And banks may not find it easy to wrest it back. According to broking firm Ambit, Indian banks have lost around 500 basis points of market share in loans to the bond market over the last couple of years.

“In the current downward rate cycle, bond market rates have shown greater sensitivity towards policy rates and the decrease in bond yields has been sharper than the decrease in bank rates, making borrowing from the bond market more attractive for corporate borrowers,” says the Ambit report.

“Over the last two years, there has been a decrease of 140bps in AAA bond yields versus just a 42 basis points decrease in the banks’ average base Rates,” the report said. This is pretty much the point Governor Rajan was trying to make while prodding banks to cut rates all through last year: if you don`t respond to market forces, you are forcing your customers to look elsewhere.

“Money market rates feed into the rates at which, say, the NBFCs borrow, and the rates at which they issue commercial paper. I think the rates eventually feed into everybody they all get the benefit of low rates and have to pass it on,” Rajan had said. Making the banks task even tougher is the RBI’s and government’s efforts to develop the bond markets.

The Ambit report says that a combination of factors like the rise of alternative financial institutions (MFs, insurers, pension funds etc.), a stable currency, low inflation environment and supportive regulations, will further strengthen bond markets` position as a source of loans. According to the broking firm, corporate bond markets have around 50 percent plus market share in the loan market in developed countries compared to just 23 percent in India.

In a recent interview on CNBC-TV18, Anish Tawakley, Financials Analyst, Barclays had said that the transmission of interest rates was more efficient in the banking system abroad. That is because banks abroad set their lending rates with reference to wholesale borrowing cost, and not according to their own cost of funds. So whenever the policy rates or expectations from the monetary policy changes, the rates are immediately reflected in wholesale borrowing costs and consequently in the base rates of banks.