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Base Rate

The banking sector has a new buzzword-base rate. It was introduced in the Indian banking system on 1 July after a directive by the Reserve Bank of India. The run-up to its implementation saw frenzied media speculation on its impact, especially on home loans for retail borrowers. However, before we discuss its effect on retail loans, it will be instructive to explore why the RBI introduced the base rate and how banks have worked out their individual rates. At the same time, it is necessary to clear some misconceptions in the public domain.
The base rate was designed to replace the flawed benchmark prime lending rate (BPLR), which was introduced in 2003 to price bank loans on the actual cost of funds.
However, the BPLR was subverted, resulting in an opaque system. The bulk of wholesale credit (loans to corporate customers) was contracted at sub-BPL rates and it comprised nearly 70% of all bank credit. Under this system, banks were subsidising corporate loans by charging high interest rates from retail and small and medium enterprise customers.
This system defeated the purpose of having a prime lending rate, or the rate that banks charge from its best customers. It also resulted in another problem: bank interest rates ceased to respond to monetary policy changes that the RBI introduced periodically.
Subsequently, in October 2009, the central bank decided to move all banks to a new interest rate system, which would not only be transparent, but also transmit monetary policy signals to the economy. Six months later, in April 2010, after a series of circulars, discussion groups and a rigorous consultative process, the RBI announced its decision to implement the base rate from 1 July 2010. Now, banks will not be allowed to lend below this rate.
Under the new rule, banks were free to use any method to calculate their base rates (the RBI did provide an 'illustrative' formula), provided the RBI found it consistent. Banks were also directed to announce their base rates on their Websites, in keeping with the objective of making lending rates more transparent. All banks operating in India announced their base rates on 1 July. Most public sector banks kept their rates at 8%, while most private banks, a few government-owned banks (such as SBI) and foreign banks kept their base rates at 7.5%.
A handful of private sector and foreign banks announced a 7% base rate. The next issue is the impact of base rate on loans, especially for home loan borrowers. Empirical evidence suggests that most such borrowers will have to pay the same interest rates as they were paying earlier. The base rate is only a starting point, a benchmark. Since banks have calculated their base rates on the cost of oneyear deposits, they will levy additional amounts as premiums.
Tenor premium (an additional slab of interest over the base rate for over a year), risk premium (depending on the risk slot in which a bank places a customer) and product premium (cost of administering a particular product) will be added to the base rate. All these premiums are legitimate and have been allowed by the RBI. Hence, the final rate paid by a housing loan borrower is unlikely to be lower than the current interest rate. This seems even more probable in the current environment of rising interest rates.
The RBI recently increased all its benchmark rates by 0.25%, the third hike in five months. This might force banks to increase their deposit rates, exerting an upward pressure on lending rates. So, customers looking to take home loans will have to shop for the best interest rates and bargain, just as they did before the base rate regime.
The writer is head of policy & research, Dhanlaxmi Bank
http://businesstoday.intoday.in/story/understanding-base-rate/1/8806.html
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Base Rate Reviewed by sambasivan srinivasan on 9:04:00 PM Rating: 5

1 comment:

saiii said...

please put all banking awareness topics in one folder to download easily

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