SBI’s downgrade will push up loan rates for firms

One fallout of the State Bank of India’s (SBI) downgrade by Moody’s Investor Services is that the bank will go real slow on credit growth due to which borrowing costs will rise sharply for lower-rated entities.

Reason: SBI will prefer to lend mostly to highly rated companies given the worries about bad loans or non-performing assets (NPAs) in its books.

Expect other state-owned peers to follow the footsteps of the SBI. Which bank chairman would want to be summoned by the finance minister following a downgrade?

What that means is lower-rated borrowers will have to veer towards private sector or foreign banks or even non-banking finance companies (NBFCs), which will seek their pound of flesh in the form of extra spreads. Why should they not?

The current borrowing cost for an AAA-rated borrower in the bond market is 9.6% to 9.7% for 2 to 5 years maturity.

NBFCs rated AA- and below are borrowing at 11.5% to 12.5% for 2 to 5 years maturity depending on the name.

The spread between a triple A and a double A borrower is 200 bps — the latter pays 2% more interest on his loan.

This will widen further if state-owned banks stop lending to borrowers rated AAA or AA+ and lower.

The market is extremely chary of lending to lower-rated credits, especially the mid- and small-cap companies. The reason is the proliferation of scams that has caught many lenders off guard.

Raids by the Central Bureau of Investigations on promoters, income tax raids and scams are all taking their toll on the risk appetite of lenders.

The fact that many companies are forced to go into the unstructured lending market to borrow at usurious rates of interest in itself is a cause for concern for banks.

Paying high interest on fresh borrowings will force many companies to defer interest and principal payments to their previous lenders, especially in times when the economy is going through a vicious cycle of high interest rates, high inflation and falling growth expectations.

Moody’s has inadvertently pushed up borrowing costs in the economy for lower-rated firms, which could potentially spawn a self-fulfilling cycle of more downgrades if credit is not made available by banks, which, in turn, will spur rating-downgrade fears.