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RBI to free loan rates from 1 April

RBI to free loan rates from 1 April
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First Published: Thu, Feb 11 2010. 05 42 AM IST

Banking reform: RBI governer D. Subbarao. Abhijit Bhatlekar/Mint
Banking reform: RBI governer D. Subbarao. Abhijit Bhatlekar/Mint
Updated: Thu, Feb 11 2010. 02 39 PM IST
Mumbai: In a move that will change the way banking is done in India, the country’s central bank on Wednesday proposed to deregulate all lending rates from the next fiscal year, beginning 1 April.
Banking reform: RBI governer D. Subbarao. Abhijit Bhatlekar/Mint
It is also replacing the current benchmark prime lending rate (BPLR) with a new concept known as base rate.
Draft guidelines posted on the Reserve Bank of India’s (RBI) website late on Wednesday said “all categories of loans should henceforth be priced only with reference to the base rate,” abolishing the system of administered rates.
RBI will accept public comments on this proposal till 17 February before issuing final guidelines. Mint had broken the story on Monday. Currently, all small loans up to Rs2 lakh given to agriculture and small industries and export loans are administered—capped at banks’ BPLR.
Although BPLR is meant for banks’ best customers, 70% of bank loans are given below the prime rate. Banks keep their BPLR at an artificially high rate because both small loans to farmers and small industries as well as export loans are linked to BPLR and when the prime rate goes down, the rates on these loans automatically decline, denting their earnings.
Loans to exporters are given at 2.5% below a bank’s BPLR. For the past few years, banks have been giving small agricultural loans at 7% with the government offering a 3% subsidy on such borrowings through a budgetary provision.
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“Since the base rate will be the minimum rate for all commercial loans...the current stipulation of BPLR as the ceiling rate for loans up to Rs2 lakh stands withdrawn,” the RBI statement said. “It is expected that deregulation of lending rates will increase the credit flow to small borrowers at reasonable rate.”
M.V. Nair, chairman of Union Bank, said the move marked a significant step in banking sector reforms. “It will bring in transparency and intensify competition,” said Nair, who also heads the industry lobby, the Indian Banks’ Association.
Not too many other bankers were willing to comment on the RBI proposal. In private, some of them said they will find it difficult to price short-term loans. “Currently, short-term loan rates can be as low as 6-7% but once we are not allowed to lend below the base rate we will find it difficult to give cheap short-term loans as the base rate cannot be that low,” one senior banker said on condition of anonymity.
Bankers will discuss this with RBI to find a different benchmark for short-term loans. BPLRs of public sector banks now vary between 11% and 13% and most private banks charge even more.
Analysts said banks’ net interest margin (NIM), or the difference between cost of funds and earnings on deployment of funds, will not be affected much as earnings on those loans which have so far been administered will go up.
RBI wants the banks to decide on the base rate depending on cost of funds, the cost of reserve requirements (banks do not earn any interest on the cash reserve kept with RBI and the earning on their mandatory investment in government bonds is also less than what they earn on loans) and a profit margin. “The actual lending rates charged to borrowers would be the base rate plus borrower-specific charges,” the RBI statement said.
The decision to deregulate loan rates follows the recommendations of an internal panel headed by executive director Deepak Mohanty. The panel was formed in June 2009 to review the BPLR system and suggest an appropriate loan pricing system. The Mohanty panel report was put up on RBI website in October, inviting comments from public, until 17 November.
For the RBI statement, go to http://bit.ly/baserate
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First Published: Thu, Feb 11 2010. 05 42 AM IST