Since 3 July, at least five government-run banks have cut their base rates. On Wednesday, Central Bank of India revised its base rate from 10.25% to 10% which will be effective July 15. Base rate is the minimum lending rate below which banks can’t lend. Other banks that have cut base rates are Union Bank of India, Oriental Bank of Commerce, Bank of India and Canara Bank. The rate cut has been in the range of 25-30 basis points (bps). One bps is a hundredth of a percentage point.
The move comes after finance minister P. Chidambaram met top officials of state-run banks and directed them to reduce rates. According to a 3 July Reuters report, after meeting the heads of state-run banks, Chidambaram said, “We have advised the banks to look at the base rate. In my view, reduction of the base rate will be a powerful booster, will be a powerful stimulus to the credit growth.”
Will this affect lending rates?
When base rate is reduced, all loans linked to it become cheaper. Say, if you have a home loan linked to the base rate, then either your equated monthly instalment or the loan tenor will go down.
The base rates came into effect only in 2010. Prior to this, banks used to lend on benchmark prime lending rate (BPLR). A majority of the banks that link the loans to base rate have a spread. For instance, State Bank of India’s base rate is at 9.70% and its home loan is priced at base rate plus 25bps—9.95%. However, there are banks that lend at the base rate itself; Bank of Baroda is an example.
Will other banks follow suit?
The country’s largest lender, State Bank of India, has already declared that it would not cut rates as it has the lowest home loan rate in the country at 9.95%. Currently, the base rate of top 10 banks based on advances as on March 2012 is between 9.60% and 10.25%.
There is no clarity whether other government-run banks will lower their base rates. Also, so far there has been no correction in rates from private or foreign banks. Says R.K. Bansal, executive director, IDBI Bank Ltd, another state-run bank, “Each bank will take a decision to cut base rate based on the cost of fund of the particular bank. So it is an individual call.”
What about banks’ margin?
It is likely that there will be no immediate impact on the banks’ margins. Says Abhishek Kothari, a Mumbai-based research analyst, “A 25 bps cut will affect the net interest margin of the bank by a maximum of 5bps. This is because currently the incremental short-term rates on deposits have also come down from 8.3% to 7.7%. Hence, the banks have a cushion on both sides.”
This is also because very few banks lend on base rate. Says Kothari, “Only 10-15% of loans are on the base rate. Hence, banks make money on the spread and on other charges such as processing fee.”
What should you do?
If you are a borrower, the lower the interest rates, the better for you. Says Surya Bhatia, managing partner, Asset Managers, “If you are planning to shop for a home loan or an auto loan don’t wait for a rate cut, but shop based on your needs. The only thing you need to do is look around for a cheaper rate.” Since there is no clarity on rate cuts yet, you should look at need-based loans.