It’s time we explore the lacunas in the corporate banking with respect to different stakeholders, i.e. clients, employees, industry. We would deliberate on the following aspects (a) art of negotiation (b) impact of divergent goals and (c) innovation, a thing of past?
Art of Negotiation:
Clients in corporate banking typically pay the following fees/charges for availing fund based facilities from banks (a) upfront/ sanctioning/ processing fees (b) Bank’s MCLR (c) Spread. Let us understand each bit in detail.
- Upfront/sanctioning/processing fee is the upfront payment generally fixed as % of total loan availed from bank for the banks RM/other departments has put in efforts and there are costs involved in running an entire process from sourcing to sanctioning to disbursement. There is no such guideline which stipulates that such fees should be charged and at times for good rated clients, that add to healthy asset quality of banks loan book, such charges are often waived so that client bank relationship is strengthened. This is subject to negotiation as there are no fixed rates. Say if it is 0.50% of total loan amount of Rs.500 cr., then upfront fees is Rs2.5 cr. As a client you have to shell Rs.2.5 cr. to get a loan from bank despite the fact that banks business is it grow its loan book and you as a client are giving that business …… Fair???
- Banks MCLR: MCLR or the marginal cost of lending rates i.e. minimum threshold below which the banks cannot lend (you may read RBI’s guideline on same, while I will try to explain its practical application). This MCLR rate is available for overnight, 1 month, 3 month, 6 months, 1 year and so on. This changes from time to time and is available in public domain for the banks.
- Spread: Spread is the added interest rate over and above the banks MCLR which the clients have to service as part of their interest payment. Spread is derived considering the factor of risk that the loan carries both from risk of the client servicing the loan as well as tenure of the loan. So a good rated client with a loan of say 3 years will be servicing a lower spread compared to poor rated clients. Is there any metric of how this spread is arrived? Well, yes, banks typically use some system, common of which is RAROC (Return Adjusted Risk On Capital) where in banks risk for lending to client is mapped from point of view of clients internal and external rating, type of loan, tenure, MCLR (1 month/3 month/1Year etc.) and a sample spread. The output gives RAROC% and there is threshold defined (say 8%) below which a bank cannot lend or has to take deviation from its sanctioning committee (that is really tough: P). So how do we tweak the parameters to get a RAROC that surpasses the threshold? You change the spread (increase it basically). Obviously it cannot be increased indefinitely because then the deal won’t happen so the spread has to be kept such that client avails loan from your banks. Needless to say, if another bank wants to acquire that client, one way is to offer lower interest rates which basically mean offer low spreads and hence this data point is confidential.
(For the more curious ones who want to know about non-fund based facilities charges, there is no applicability of MCLR or spread. Instead non-fund based facilities is charged on commission basis and may be tied to number of days for which the non-fund based facility is provided. For example if you are availing letter of credit, for say Rs.100 cr. for an year, and commission is 1% then, commission is Rs.1 cr. Why such low commission? Because there is no upfront actual cash payment by the bank and actual outflow of cash will happen in case borrower fails to pay to its supplier/or fails to deliver as per its performance obligations).
Where is the lacuna here? This is all process and simple….
The RM’s are smart, well for bringing in business, meeting their target goals, they have to. So suppose you are a client who approaches a bank for loan. RM will negotiate with you on upfront fees as well as spread along with other commercial terms. RM will take an approval from their committee at a lower level; say nil upfront fees and spread (say 1.5%) that just passes the RAROC threshold for meeting banks threshold criteria. On the other hand, the client would be quoted upfront fees of say 0.5% of the loan amount and spread of 2% (over and above the banks MCLR) and because these parameters are not available for other banks or are standard, you as a client will not be able to ascertain the best pricing at which your finance costs could be minimized. This is the lacuna we are talking about and every bank (at least for private sector), this differential in rates at which loan is offered to client vs. what is acceptable to a bank is kept on the table by the client and banks smilingly sweep into their pockets. Needless to say, art of negotiation can save a lot of money that is just being forgotten on the table by the client.
Impact of divergent goals
Every quarter when a result of any bank is disclosed in the public domain, investors are curious to know about the GNPA/NPA levels. Gross non-performing assets or non-performing assets indicate the health of asset quality of banks loan book. While the bank makes money by lending and charging interest rates (spreads etc. which we talked about above), the bank has to ensure that its principal gets paid in full at the end of tenure of loan. In case of stress in business, client’s ability to pay back the principal portion of loan, (forget interest portion) might be difficult. So how an account/client does becomes NPA? Well the guideline says that in case a loan repays unpaid for more than 90 days after its due date, it becomes as NPA and banks have to make necessary provisions in their books of account which impacts the profit of the banks and hence this parameter is critical to the investors. Higher NPAs indicate loss of profitability, YES?
What is the solution? Switch to better rated clients whose probability of default is low? Simple…duh!
Well, easier said than done. As the companies expanded in India, so did the number of banks and their plans to increase their asset book. Inside the banks, there are different teams with their deliverables. While RM’s role (for detail you may refer to article https://www.minervagc.com/corporatebanking1/) is to grow the business of bank by getting more and more clients, the risk department has to be watchful and flag any accounts/clients that might face stress either on account of industry, business, promoter factors amid others. And here is where the divergence kicks in, the business side is tasked with increasing loan book and risk department has to prune that to weed out any potential stress.
Consider a situation where you are a RM (relationship manager) and daily your boss shouts on you for failing to deliver on your target. The market is already pretty saturated and all good rated assets are eyed upon by the competitor banks as well. Sweating, running from client to client, you finally manage to source a potential target and as usual that client gives you a time bound request for loan. Half of the work is done… phew or is it? Remember how the risk department pointed out key risks in your last proposal note and that led to rejection of sanction and there went down the drain all efforts done for sourcing. But we as humans learn from our experience, right. So this time, let us make the loan proposal a little favorable so that win rates can be maximized. But that does not mean misrepresenting the facts as that will be fraud. What can be done is being selective in what is to be projected on paper. Not talking about a particular aspect is unquestionable, no one can ask unless they know. And anyways it was the risk departments deliverable to conduct proper due-diligence. And in some banks, if the RM or the credit analyst has to conduct the internal rating as well before submitting to risk department, a bit of tweaking can help here as well. Finally, who does not wants to have prosperous relationships with its other employees, so why not leverage the relationship with fellow team members in other departments whose approval might be critical sanctioning of the loan. There you go, proposal appraisal bias, internal rating bias, leveraging relationships and all the tricks in your sleeve will help you get the deal done, a pat on your back from your boss and a bonus (if you are lucky and the bank’s performance has been good and there is no Covid: P)
Innovation, a thing of past?
Well for the problems stated above and many others, innovation can be a solution. Graduating from top notch B-schools, ICAI, and other professional institutes, there is a lot of expectation with which you join any organization. But then reality hits you that learning in classroom was bit more theoretical while the actual job deliverables are different. This time cycle of learning the scope of work in new job cuts little for innovating. As a result, the products are standard, saturated and anyways, who likes to work overtime to put efforts for innovation.
There are product related departments that cater to innovation, delivery, feedback but cycle from ideation to pro-type testing to market feedback to final implementation may be so long that by the time a product is launched in market, it might no longer be needed or the regulations might not be favorable. Technology is one thing we can bet on. Perhaps that is why all top banks are engaging with startups in fin-tech space to co-develop products that are suited for future.
By:
Nishant Gupta
(Email id: nishant@minervagc.com)
Disclaimer: The views and opinions expressed in the article are those of the author and do not necessarily reflect the official policy or position of any other agency, organization, employer or company. Since we are critically-thinking human beings, these views are always subject to change, revision, and re-thinking at any time. Please do not hold us to them in perpetuity.