For years, home loan borrowers on floating rates felt cheated by banks as they paid more when interest rates rose, but did not pay less when they fell. Banks kept rates high for old customers and reduced them for new ones by keeping the benchmark prime lending rate (BPLR) sticky.
To deal with this problem, among others, the Reserve Bank of India (RBI) on Wednesday announced the move from a BPLR model to a base rate system, effective 1 April. The new rate will apply to all fresh loans but old loans, when they come up for renewal, can switch.
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Why BPLR didn’t work?
Not only did banks set BPLR in a non-transparent manner, they had several BPLR rates, each for a different category of loans—corporate and retail to name two. Some pushed the envelope far enough to have two benchmark rates for home loan borrowers. When rates went down, instead of floating existing borrowers down, the bank simply announced another (lower) PLR with a different name for new customers.
What is base rate system?
If you are a home loan borrower, the rate you see will be a sum of two costs: a base rate plus borrower-specific charges. A bank faces several costs. The first, called base rate, is common across all borrowers and will be made up of the cost of deposits (or what it costs the bank in interest payments to keep your money as deposits), the money notionally lost by the bank in statutory obligations that throw off no interest, general overhead costs and profit margin. Add to this the specific cost due to the product you buy, its tenor (length) and your own credit risk.
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Product-specific costs mean that an unsecured loan would have a higher cost attached to it compared with a home loan, which has the house as the collateral.
Your credit rating with Credit Information Bureau (India) Ltd (Cibil) will now come into play and people with good credit scores will see the charges related to their own risk come down, meaning lower rates. Tenure-related cost would mean that the longer the loan is held, the higher the cost.
Will it work?
Just moving to a new system will not reduce rates. Neither will it mean a fairer deal for older borrowers. There are already enough loopholes for banks to continue charging differential pricing not linked to borrower risk. Says K. Unnikrishnan, deputy chief executive, Indian Banks’ Association: “This will not impact the borrower in any drastic way. How the industry will respond to this and how it will come out in actual practice we will have to wait and see.”
What this system will do is increase transparency. Says Adhil Shetty, CEO, BankBazaar.com: “It’ll increase transparency in pricing because if deposit rates are reduced then the bank will hopefully reduce its base rate, making all loans (new and old) cheaper. But this is not mandated by the RBI proposal.”
Agrees Kartik Varma, co-founder, iTrust Financial Advisors Pvt. Ltd: “The cost of borrowing isn’t changing, just the ability to understand, how the rate has been arrived at has got a little bit easier since the base rate for most banks will be almost similar.”
We’ll have to wait for the banks to respond with actual rates and products, but today, the base rate can best be seen as a step towards a more transparent system of a third-party benchmark-linked rate (like the Mumbai inter-bank offered rate).
You can read the circular at www.rbi.org.in and send your suggestions and comments till 17 February through email (mail straight from RBI site) or fax to 022-22610430 or write to the adviser-in-charge, monetary policy department, Reserve Bank of India, Central Office Building, 24th Floor, SB Singh Marg, Mumbai-400001
Compiled by Sidin Vadukut and Graphics by Yogesh Kumar/Mint