Banks to move from BPLR to 'Base rate': Implications

The issue of Banks differentiating between old and new borrowers has come under the scanner of 'Competition commission'. Existing borrowers feel cheated when their bank offers a lower rate of interest to the new borrowers, while they are not allowed a reset for their existing outstanding loans. If they want to liquidate the loan and move to another lender, they are required to pay a hefty pre-payment penalty ranging anywhere between 1-3%. Banks have justified this juglery on the pretext that they need to protect their Net Interest margin (NIM), and the banks can offer loan reduction to existing borrowers only with a time lag, because they need to overcome the mismatch between their asset and liability buckets. Moreover, with more than 50% of the loans sanctioned at sub-BPLR rates the concept of the BPLR has been rendered redundant.

To enable the banks to set their lending rates in a scientific and transparent manner, the Reserve Bank of India has proposed a system that will replace the existing system of benchmark prime lending rates (BPLR) with base rates. The formula for calculating the base rate will take into account the cost of deposits, cost of complying with CRR and SLR requirements, and the need to retain a profit margin. There will be a markup depending on the cost of operation for a particular type of product and premiums for credit risk and tenor of loans. The existing BPLR system does not quickly or adequately respond to changes in policy rates, thus reducing the effectiveness of monetary policy. Transparency will be enhanced under the new syatem. The priority sector lending at sub-BPLR rates will be unaffected as the base rates will be set much lower than the existing BPLR of the banks.

Based on the 2008-09 numbers, the base rate varies from 5.22% for Citi to 8.91% for OBC. Broadly speaking, foreign banks have the lowest rate followed by public sector banks and then private banks. Currently, the PLR of most banks are more or less the same. It would be interesting to find out  that once the base rate scale is known to all potential borrowers and varies according to a uniform predetermined formula, potential customers would have a choice provided the banks have the willingness. With savings bank deposit rates set to be calculated on daily balances from 1.4.2010, banks profitability will be under some more pressure. Most Banks have sought period till the end of June 2010 for implementation of the new lending regime.