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Banks chase small firms to protect loan margins

Banks are courting smaller companies with attractive lending arrangements as competition squeezes earnings from retail loans.

india Updated: Jan 25, 2006 19:06 IST
Reuters
Reuters
None

Banks are courting smaller companies with attractive lending arrangements as competition squeezes earnings from retail loans, but the new effort to protect profit margins also carries greater risks.

The average yield on loans to small or medium companies range between 9.5 per cent and 11 per cent a year, compared with about 7 per cent for big companies and 7.5 per cent to 9 per cent on retail loans.

"When the margins in corporate banking thinned, all the banks moved to retail and when the same thing is happening in retail, banks are moving towards SMEs," said Hemant Kaul, president at UTI Bank, in which HSBC holds a 12.2 per cent stake.

Small and medium enterprises, or SMEs, were defined by Crisil Ltd, the Indian unit of Standard & Poor's, as firms with sales up to Rs 1 billion ($22.5 million), but some banks have stretched the limit to Rs 2.5 billion.

Crisil also recently started rating SMEs, as banks began seeking to do business with them.

"The sector is quite vulnerable," said Vijay Chandok, general manager at India's largest private sector lender, ICICI Bank. "That is why we focus very heavily on their underlying business model."

In the 1990s, banks were forced to write off billions of rupees in loans to smaller companies after their businesses faltered with economic reforms that opened them to competition in 1991.

Some bankers say the smaller companies are now much stronger, while the ratings help to reduce the risk for lenders.

"The fortunes of smaller companies are twinned with those of bigger ones to whom they are suppliers," said Anil Khandelwal, chairman of state-run Bank of Baroda.

"When the big companies are doing well, their suppliers also tend to do well," he said.

Banks need to grab the opportunity presented by smaller companies to offset dwindling margins.

HDFC Bank, India's second-largest private sector bank, posted a 10-basis-point drop in net interest margins in its third-quarter ended December 31 from the September quarter.

The central bank and the government are now encouraging loans to smaller companies because the sector has the potential to create jobs for India's billion-plus people, and help spread the benefit of near- 8 per cent economic growth.

The SME sector has also opened the potential for advisory services and fee incomes that private sector banks rely on to boost their earnings.

"We also think of value addition," said Chandok of ICICI Bank, which has put in place a separate SME cell. "There's a good deal of banking opportunity -- like wealth management services as the businesses grow." ICICI posted a 52 per cent jump in fee income in its fiscal third-quarter ended December 31, compared with a year earlier.

"SMEs were less talked about and it was fashionable to look at just triple-A rated companies." Chandok said. "But it has come full circle now."

Banks are courting smaller companies with attractive lending arrangements as competition squeezes earnings from retail loans, but the new effort to protect profit margins also carries greater risks.

The average yield on loans to small or medium companies range between 9.5 per cent and 11 per cent a year, compared with about 7 per cent for big companies and 7.5 per cent to 9 per cent on retail loans.

"When the margins in corporate banking thinned, all the banks moved to retail and when the same thing is happening in retail, banks are moving towards SMEs," said Hemant Kaul, president at UTI Bank, in which HSBC holds a 12.2 per cent stake.

Small and medium enterprises, or SMEs, were defined by Crisil Ltd, the Indian unit of Standard & Poor's, as firms with sales up to Rs1 billion rupees ($22.5 million), but some banks have stretched the limit to 2.5 billion rupees.

Crisil also recently started rating SMEs, as banks began seeking to do business with them.

"The sector is quite vulnerable," said Vijay Chandok, general manager at India's largest private sector lender, ICICI Bank. "That is why we focus very heavily on their underlying business model."

In the 1990s, banks were forced to write off billions of rupees in loans to smaller companies after their businesses faltered with economic reforms that opened them to competition in 1991.

Some bankers say the smaller companies are now much stronger, while the ratings help to reduce the risk for lenders.

"The fortunes of smaller companies are twinned with those of bigger ones to whom they are suppliers," said Anil Khandelwal, chairman of state-run Bank of Baroda.

"When the big companies are doing well, their suppliers also tend to do well," he said.

Banks need to grab the opportunity presented by smaller companies to offset dwindling margins.

HDFC Bank, India's second-largest private sector bank, posted a 10-basis-point drop in net interest margins in its third-quarter ended Dec. 31 from the September quarter.

The central bank and the government are now encouraging loans to smaller companies because the sector has the potential to create jobs for India's billion-plus people, and help spread the benefit of near-8 percent economic growth.

The SME sector has also opened the potential for advisory services and fee incomes that private sector banks rely on to boost their earnings.

"We also think of value addition," said Chandok of ICICI Bank, which has put in place a separate SME cell. "There's a good deal of banking opportunity -- like wealth management services as the businesses grow." ICICI posted a 52 per cent jump in fee income in its fiscal third-quarter ended December 31, compared with a year earlier.

"SMEs were less talked about and it was fashionable to look at just triple-A rated companies." Chandok said. "But it has come full circle now."

First Published: Jan 25, 2006 19:06 IST