ponderings & pennings

Today’s Business Line carries a report that banks in India are preparing to hike discounts to their PLRs.

This is being done in order to stimulate credit offtake in the peak season. Now as per me this contradicts what we learn in risk management.

The spread (premium if positive and discount if negative) represents the perceived risk in any asset. The spread changes only when the risk perception changes. This spread is on some base number. In this case the asset is the loan to companies and the base is the PLR. The PLR represents the rate at which any bank would lend to its best customer and the spread on it represents the risk perception that any company has in view of the bank and this risk is in comparison to the bank’s "best company". A higher risk will get positive spread (premium) and a lower risk will get negative spread (discount).

Now when the banks say that they will change the discount (or premium) they imply that the riskiness of the companies (customers) has changed; in this case it seems the riskiness has reduced as they are talking of hiking the discounts. The contradcition is that this is not the reason that they are stating.

The reason is to stimulate the credit offtake. For this I believe the way is to change (decrease here) the base i.e. PLR. The spread should be changed only when the risk factor changes.

Another flaw in this is that this stimulation for credit offtake will then be limited to companies that are already enjoying a discount. If the credit offtake has to be increased then it should be across the table. Or is it that the banks fear some kind of sub-prime crisis in India?

Here is another of my favs: