Is it true that banks are lending at below the repo rate and what does that mean for the markets?

That is a very recent phenomenon and banks do not have much of a choice as they are stuck with a glut of liquidity in the current macro situation. Too much liquidity in the system is creating a different type of problem for banks and this is the direct outcome.

There are two reasons for this liquidity glut in the financial system. Firstly, the recent RBI intervention in currency markets boosted liquidity. Secondly, the slew of liquidity infusion measures induced some banks to extend long-term loans to corporates below the repo rates in the midst of tepid loan growth.

In a recent reported, SBI has warned against this pernicious practice pointing that the idea was absolutely unsustainable and could also have negative repercussions. SBI observed in a research note that 15-year bank loans were given at negative spread of 70 bps over similar rated corporate bonds. In some cases, the lending was also below repo rates.

The reasons are quite obvious. Most banks in India today are saddled with excess liquidity and have no avenues to lend due to tepid credit demand. Hence banks are outbidding each other to lend below bond market rates.

In a related statement, SBI has warned in its latest report that this practice could hit bank profits deeply and worsen asset liability mismatches substantially. The real anomaly was that AA rated borrowers ended up getting loans at lower interest than blue chip AAA rated borrowers and that was distorting the lending picture.