bank lending: Tweak for banks to scale up lending

In an interview to ET, Kotak Mahindra Bank managing director Uday Kotak rightly underscored the need for rewriting the rules governing the Indian financial sector to realise the economy’s growth potential. RBI norms restrict Indian banks from lending to companies for takeovers. This places domestic banks at a disadvantage against their global rivals and they don’t have the leeway to build scale. An easing of this rule will help banks. Today, they can lend only up to ₹20 lakh against shares, a rule set after the 1992 Harshad Mehta scam. RBI always viewed lending against shares as a risky activity as a sudden collapse in stock prices could leave banks holding worthless paper.

Equity shares are an asset class, just as gold and real estate. Banks sanction loans against gold. The rules say that loans sanctioned by banks against pledge of gold ornaments and jewellery should not exceed 75% of their value. Simply put, gold loans attract a loan-to-value (LTV) ratio of 75%. The balance value of the gold held by the bank acts as a margin of safety to protect it against any volatility in prices. RBI can raise the limit for loan against shares, and similarly prescribe LTV ratio for shares in takeover funding. Banks, too, should have a robust and rigorous valuation system to assess the inherent value of shares and a buffer to withstand any loss in the market price.

The timing is opportune – a ‘Cinderella moment for the banking industry’, in Kotak’s words – now that corporate balance sheets are deleveraged. Companies paid off expensive debt when interest rates were low. Public sector banks have also cleaned up their books, enabling them to lend more. Reviving the corporate investment cycle – ‘animal spirits’ – will aid faster recovery.