The base rate system will soon become a part of the Indian banking system. Many of us must be wondering if this will impact our borrowing and whether there is any benefit from this change proposed. Here are a few factors that will play out once the new system comes into effect.
THE NEW BENCHMARK
The base rate is to be fixed by individual banks, based on their cost of funds. This will mean each bank will do its individual calculation (as recommended by the central bank) and arrive at the base rate valid for itself. Banks cannot lend to any customer below the base rate, except for some specific category of lending such as those with a subvention from the government, lending to employees, etc. However, all the major borrowing areas for individual customers like home loans, auto loans, personal loans and so on will be covered under the base rate system.
VARIABLE LOANS
The base rate will impact variable loans on a consistent basis. This will happen because the interest rate on loans is linked to other rates like the currently applicable prime lending rate (PLR) or a benchmark prime lending rate (BPLR). Now the interest rate on loans will be linked to the new base rate and hence a change in this rate will impact the loan seeker.
On the other hand, fixed rate loans will face only nominal impact. The fixed rate charged would have a floor present in the form of a base rate. These loans will not be impacted on a regular basis, as the rate is fixed at the time of taking the loan and hence that rate would largely be unchanged for the entire tenure of the loan.
several factors would determine the actual rate they end up paying on their loan(s). The actual rate charged will be base rate plus borrower specific charges including product specific operating cost, credit risk premium and tenure premium.
For instance, auto loans (which do not have the same kind of security as a housing loan) will be more expensive than home loans. The are transparency and banks go about this process will have to be seen. If there are differences in bank base rates and borrower specific rates, then there will be a choice available to the clients. But, if most banks follow a similar route and have a similar base rates, then the expected benefit might not come through.