Once upon a time, there was a king who did not wish his feet to get dirty while walking on the streets. So he announced a hefty award for somebody who could devise a way to keep the king's feet clean.
First, it was the turn of a gentleman from a neighbouring state who was eyeing the hand of the princess as part of the award.
He promised to do the job within a few days. He employed thousands of sweepers to keep the kingdom clean and free of even a spec of dust.
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Then came a neighbourhood butcher with a radical idea. He started killing millions of cows and goats. The objective was to cover the entire kingdom with hide so that king's feet would not need to touch the dust.
The roads had a blood bath and the dust turned into thick mud but the butcher could not accomplish his job because angry animal activists drove him away.
When a dejected king lost all hope, an old cobbler walked in with a sling bag dangling from his drooping shoulder, carrying few nails, a bottle of glue and a small piece of hide. He sat on the floor of the royal court, took the king's feet on his lap, measured them carefully and within hours produced a pair of sandals. The king's feet would never get dirty again!
This apocryphal drama is now being enacted on Mint Road, albeit in a different context. Banks are not transparent in fixing their lending rates and some of them are taking their customers for a ride.
The solution, the Reserve Bank of India feels, is to have one benchmark prime lending rate for all loans irrespective of their profile or maturity.
This is as good as the use of a million brooms to make the kingdom dust-free or killing of animals to cover the kingdom with hide so that the king's feet can remain dust-free.
The simple solution could have been to allow banks to have sectoral PLRs and force them to put the rate cards on the table.
The trigger for the RBI's move is possibly the anarchy that rules the home loan market.
Home loan rates are coming down every day and there is no method in the madness.
Even though the banks refuse to admit it, the fact remains that some of them have delinked the home loan rates from their PLR.
So far, however, only the new customers get advantage of this fall because the old customers continue to pay the higher rates at which they had raised their loans. Logically, with every rate cut, all floating rate customers should get the benefit but that has not been happening.
Some of the players have even gone to the extent of making the rate charts redundant and allowing their front desk to fix the loan rates, depending on the profile of the customers.
In other words, the rates have become negotiable depending on the bargaining power of the borrower and cost of money and liquidity chest of the lender.
This has largely been happening because there is only one PLR now for industrial loans as well as home loans and other personal loans. The products as well as the underlying securities that back the loans are entirely different.
The cost structure too is different as the levels of non-performing assets in different segments are radically different.
For instance, credit card and personal loans are unsecured loans with high delinquency rates while home loans are fully secured and the NPA level is below 1 per cent.
Ideally, there should be different PLRs for different loans, depending on their profile and maturity. But the regulator wants the banking industry to have a benchmark PLR for all products.
If this is forced down the throat of the industry, it can certainly achieve transparency but at what cost?
Clouds of information will envelop the reasoning of the customers and may even end up killing the fledging floating rate loan market.
How can that happen?
Once this is put in place, a bank will first announce its benchmark PLR for all products, then load term premiums (which will vary depending on the maturity profile of the loans), product premiums, risk premiums and another half a dozen premiums or discounts (depending on the product and profile of the borrowers) to arrive at the final rate.
All this jargon will hardly make any sense for an average borrower. With every rate change, the jargons will increase explaining the rationale behind the change.
So banks will be transparent but customers may refuse to get tired by reading the fine print.
The RBI in its April Credit Policy had first hinted at creating a benchmark PLR.
According to RBI, banks should take into account their actual cost of funds, operating expenses, a minimum margin to cover regulatory requirement of provisioning on account of NPAs and profit margin while arriving at the benchmark PLR. But the ground reality is a bit different.
For instance, what is the actual cost of funds? Is it the blended cost of a bank's outstanding liabilities or the marginal cost of new liabilities? What about transfer pricing mechanism? Or, for that matter, capital allocation to different products?
Most importantly, how can there be one benchmark for all products of all maturities. Globally, PLR is applicable to overdrafts. Project loans and retail loans are a different kettle of fish and there cannot be one-size-fits-all approach.
If the RBI wants market forces to have a say in the entire exercise, then commercial paper, treasury bills and even Mibor (Mumbai inter-bank offered rate, an Indian counterpart of the London inter-bank offered rate) can influence the short-term rates while long-term loans can have different benchmarks.
Ironically, the intense debate on the benchmark is taking place at a time when the three-legged animal is on the verge of extinction.
Technically, only the prime borrowers can avail of loans at prime rates but it has not been happening because triple-A- rated borrowers can always raise money from the market at a price cheaper than a bank's cost of funds.
This is a global phenomenon as there are more triple-A-rated corporations than triple-A-rated banks. As the twin factors of abundance of liquidity and lack of credit offtake burden the banking industry, even lesser rated corporations have started raising bank loans at below PLR.
Ever since tenor-linked PLR was allowed, most of the banks switched to three sets of PLR for short term, medium term and long term. The dividing lines are getting blurred as PLR itself is turning into an anachronism.
The best possible way of bringing in transparency could be either abolishing the concept and allowing market forces to take over or introducing sector-specific PLRs.
The National Housing Bank can be roped in to frame a separate PLR for home loans.
The RBI also must ask the banks to be transparent in their disclosures in balance sheets. In its present format, a bank balance sheet is like a black box.
It hides more than it reveals. For instance, no Indian bank publish segmented results on the lines of global banks.
This is because they are not required to do so. Let them disclose the results of each segment of their business with every minute detail like profit, cost of fund, net interest margin, allocation of capital. Let them also make public the transfer pricing mechanism.
Since most of the Indian banks are listed, they owe this to the public. This will make abundantly clear how they are performing in each areas of business and whether they are compromising margins in certain segments like home loans in the mad scramble to acquire customers.
Once this is done, the hide-and-seek game on PLR will automatically end.