How does the new base rate matter to you?
Any loan you take from a bank will be at an interest rate linked to the base rate.
The rate will be fixed by adding a certain borrower-specific charge to the bank's base rate. The base rate will also be the reference benchmark rate for floating interest rate loans that you take from a bank. Individual borrowers who have home loans on floating rates, the base rate will matter a lot. RBI has mandated that banks do not lend below their respective base rates after July 1.
How will it be calculated?
Individual banks will calculate their base rates by factoring in
(1) The interest rate on retail deposits (for amounts below Rs 15 lakh) with one-year maturity,
(2) The negative impact of RBI's prescription of cash reserve ratio or the proportion of cash that a bank needs to keep with RBI and statutory liquidity ratio or the minimum reserve that a bank needs to keep in cash,
(3) Unallocatable overhead cost for banks, and
(4) Average return on the bank's net worth.
What is the benchmark rate at present?
The base rate regime kicks off on July 1.
The previous benchmark for pricing loans was benchmark prime lending rate or BPLR. Till now, BPLR mattered for borrowers of loans up to Rs 2 lakh. It served as the RBI-mandated ceiling for these loans. Also, interest rates of many banks' floating rate home loans used to be benchmarked to BPLRs. BPLRs.
Why is BPLR being replaced?
A 13-member working group, constituted by the Reserve Bank of India last year, said in a report in October 2009, "The BPLR system was expected to be a step forward from the PLR system, which more or less represented minimum lending rates, to that of one which stood as a benchmark or a reference rate around which most of the banks' lending was expected to take place. However, over a period of time, several concerns have been raised about the way the BPLR system has evolved. These relate to large quantum of lending below BPLR, lack of transparency, downward stickiness of How cross-subsidisation took place?
The RBI group itself noted that "there was widespread public perception that the BPLR system led to cross-subsidisation in terms of underpricing of credit for companies and overpricing of loans to agriculture and small and medium enterprises." So, when you went to a bank to take a loan, you were charged at BPLR that will be pegged at a high level even though interest rates in the market were coming down. But if a large company went to the same bank, it would get a loan at a big discount to the BPLR, referred to as `sub-BPLR lending'.
How will the base rate be better?
In addition to the problems mentioned above, that affected you directly or indirectly, the BPLR system was also backward-looking. It factored in elements from loans already disbursed by a bank and ignored present market conditions. The base rate will include cost elements, which are clearly identifiable and common across borrowers. And you will be charged for a loan at base rate plus a charge that will be based on the bank's variable or product specific operating expenses, your credit risk and the premium for the tenure you are taking the loan for.
Should you blindly trust the base rate?
The base rate can be trusted. RBI has made it compulsory for banks to reveal all information on base rates and also disclose its maximum and minimum lending rates compulsorily. This will make the base rate figures reliable. But the complex factors that the base rate is based on could lead to erratic rates among different banks. Also, the final lending rate that a bank can charge may still throw up nasty surprises. You can be charged very high product costs and be told that your credit risk premium is high.
