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Base Rate System and Its role in transparency

Feb 17, 2010 RBI

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RBI guidelines describe base rate as follows: ‘The Base Rate system will replace the BPLR system with
effect from April 1, 2010. Banks may determine their actual lending rates on loans and advances with
reference to the Base Rate. Base Rate shall include all those elements of the lending rates that are
common across all categories of borrowers. While each bank may decide its own Base Rate, some of the

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criteria that could go into the determination of the Base Rate are:

Cost of deposits;

Adjustment for the negative carry in respect of CRR (cash reserve ratio) and SLR (statutory liquidity
ratio)

Unallocatable overhead cost for banks such as aggregate employee compensation relating to
administrative functions in corporate office, directors’ and auditors’ fees, legal and premises
expenses, depreciation, cost of printing and stationery, expenses incurred on communication and
advertising, IT spending, and cost incurred towards deposit insurance; and

Profit margin.’

In simpler terms what this means is that instead of depending on the BPLR to decide the rates at which
banks lend to borrowers they now will have a more rational reference point to decide the rates.

All loans given after April 1, 2010 will be calculated as Lending rate = Base rate + X. The variable ‘X’
will be based on parameters fixed by the banks which could include operating costs, duration of loan,
risks involved, et cetera. This would also include charges relating to specific borrowers.

RBI has instructed the banks that the base rate should also be the reference point for products with a
floating rate component. It also clearly stipulates that even in cases where the benchmark is an external
rate, the rate at the time of disbursal of loan should be higher than the base rate.

How does it bring more transparency?

RBI has clearly stated that irrespective of the parameters based on which a bank fixes the base rate, the
rate has to be clearly displayed at all branches and the websites of the banks. Any changes to the rate
have to be promptly conveyed to the common public.

Banks have also been advised to inform the Reserve Bank of the minimum and maximum rates charged
to their customers on a quarterly basis.

More importantly the central bank has warned banks not to lend below the base rate under any
circumstances. This is seen as a move that will ensure that large borrowers do not use their purchasing
power to squeeze very low rates of interest.

How will it help the common Indian?

The earlier rule stating that loans below Rs 2 lakh (Rs 200,000) have to be charged at above the BPLR
rate has been taken off. This in effect means that small borrowers can now expect a lower rate of interest
for their new loans. (Although it must be admitted that it seems very farfetched that banks will really
give a very low rate for these loans as the ‘customer specific’ charges for low quantum loans are high
enough to wipe off the savings generated by moving to the new system).

Higher credit flow could ensure that small borrowers can at least afford to ignore other stressful sources
of funding like pawn brokers, etc.

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What about existing loans?

The new system has been mooted for all loans given after April 1, 2010. Existing customers can have a
discussion with the bank and finalise upon a mutually accepted rate based on the new system.

The new system will surely be a good sign for small borrowers but could give a few sleepless nights to
big borrowers who could see their rates of borrowing move northwards. The first week of April 2010
could provide a clearer picture of how each bank tackles and implements the new system.

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Tags: and SLR, BPLR, cash reserve ratio, CRR, statutory liquidity ratio

This entry was posted on Wednesday, February 17th, 2010 at 1:07 am and is filed under RBI. You can follow any responses
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