At a time when the market conditions are uncertain, banks are playing safe to protect their profit margins. As a result the lenders are fixing the floor rates on loans that are given below their benchmark prime lending rate (BPLR)
Fixing a floor rate means that each time the BPLR of a bank decreases, the lending rate linked to PLR will not be reduced below the fixed level. In fact the banking industry leaders including State Bank of India, Indian Overseas Bank, IDBI Bank, Corporation Bank, Union Bank of India and Punjab National Bank have begun fixing floor rates on loans below PLR on a case-to-case basis.
A PSU Bank official said, "While in the past there were very few instances of banks fixing a floor rate on loans, it is happening more frequently now."
Although big corporates are demanding lower interest rate yet banks are hesitant and fixing floor rates because their profits are been affected. If bank has a PLR of 12% and a corporate has bargained the loan at 2% below PLR, the bank's profit margin would fall if the PLR is lowered. However if the floor rate is fixed at 8.5% then no matter how much the PLR falls, corporate has to pay an interest rate of 8.5%.
Meanwhile banks are also worried that they may not be able to reduce the deposit rates significantly and hence if they do not fix floor rate, profits would come at stake.
Most banks are fixing the floor rate on loans extended for a longer term for projects such as road and ports while some other banks have fixed the floor rates on loans given to real estate companies, non-bank finance companies (NBFCs) and small and medium enterprise (SME) segment.
Earlier in 2004 when the interest rates fell sharply some banks had fixed the interest rate at 7% for three year tenure but when the interest rate cycle changed in 2005, these banks suffered heavily.
Hence this time the banks are resorting to practice of fixing the floor rate to avoid the losses if the interest rate rises after some time.