Mumbai: Banks may have to pursue a dual-rate system for many more years because the regulator is not inclined to accept their demand to set a deadline for the conversion of loans linked to the benchmark prime lending rate (BPLR) to the new base rate regime.
The base rate, introduced in July, has replaced BPLR.
Theoretically, a bank’s best borrowers are entitled to raise money at BPLR, but around 70% of them used to get loans at below BPLR. The base rate, on the other hand, is the floor for all loan rates below which no borrower can raise money.
The base rate replaced BPLR in July to introduce more transparency in loan pricing. The original plan was to continue with BPLR for existing borrowers for one year and then have them migrate to the base rate with a sunset clause.
In public policy, a sunset clause is a provision that terminates or repeals all or portions of an existing arrangement after a specific date.
However, because all loans are contracts between banks and their customers, the Reserve Bank of India (RBI) cannot enforce such a clause for BPLR-linked loans.
“We have checked the legal implications. It cannot be done,” said an RBI official familiar with the development. The person did not want to be named.
The continuation of BPLR may not have a significant impact on the cost of funds for borrowers because there is not much of a difference between the effective interest rate under both BPLR and the base rate regimes. But banks will be burdened with additional work to administer a dual-rate system.
Most banks, including the nation’s largest lender State Bank of India (SBI) and the largest private sector lender ICICI Bank Ltd, have fixed their base rates at between 7.5% and 8%. A few private and foreign banks have kept it at even lower levels.
In contrast, BPLR of public sector banks ranges between 11.75% and 12.5% and that of private and foreign banks could be as high as 16%.
Only a few top-rated customers can raise loans at the base rate and others have to pay a premium over the base rate. But most of those who had raised loans linked to BPLR pay less than a bank’s benchmark rate.
Most long-maturity loans such as mortgages and infrastructure loans are linked to BPLR. If these borrowers do not voluntarily migrate to the base rate system, banks will have to continue to keep the BPLR regime.
“About 80-90% of loans are linked to BPLR. This is a huge operational issue,” said a senior banker who didn’t want to be named.
According to RBI guidelines, existing BPLR loans can be shifted to the base rate when a loan reaches the reset or maturity date or if the customer opts for it.
“Banks will have to honour the contract with the customer in order to take care of their interests. One possible way to overcome this issue of conversion from BPLR to the base rate is to make a supplementary agreement to the existing loan contract,” said Robin Roy, an assistant director with the consultancy PricewaterhouseCoopers Llp.
All new loans will have to follow the base rate system.
“Banks have been asked to convince the customer about the new model, thus enabling a gradual transition to the new regime, rather than imposing it on the borrower. It is not appropriate for the regulator to ask bank customers to compulsorily shift their loans to base rate,” said Allen C.A. Pereira, chairman and managing director, Bank of Maharashtra.
According to a senior industry official, the apex bank’s legal department did not favour the introduction of a sunset clause as it felt that this would clearly go against the spirit of loan contracts.
Banks have lobbied hard for a sunset clause. In July, SBI chairman O.P. Bhatt had said that RBI is likely to favour such a clause, with a period of one year ending 30 July 2011, to help banks achieve a smooth transition.