Mumbai: The Reserve Bank of India (RBI) announced on Friday that banks will have to determine their lending rates with reference to the base rate effective 1 July. Additionally, the base rate will have to be reviewed at least once every quarter with the approval of the board or the asset liability management committees (Alcos), as per the bank’s practice, RBI said in a notification.
The so-called base rate is a new concept that will replace the current benchmark prime lending rate (BPLR) in an attempt to improve transparency in banks’ lending rates and to enable better assessment of transmission of monetary policy. The central bank has given banks freedom to use any methodology to compute the base rate, or the minimum below which they will not be permitted to lend money, provided it is consistent and is available for supervisory review or scrutiny, when required.
Though BPLR is meant for banks’ most creditworthy customers, typically 70% of loans are given below that rate. Banks keep BPLR artificially high because both small loans to farmers and small industries as well as export loans are linked to it. When the prime rate goes down, the rates on these loans also decline, which would dent banks’ earnings more if loans were at BPLR. The central bank has also withdrawn the current stipulation of BPLR as the ceiling rate for loans up to Rs2 lakh.
RBI had asked banks to decide the base rate depending on the cost of funds, cost of reserve requirements and a profit margin.
The base rate system will be applicable for all new loans and for old loans that are up for renewal. Existing loans based on the BPLR system may run till their maturity, RBI said.
The central bank has also asked banks to give existing borrowers a free option to switch to the new system, before expiry of the existing contracts, on mutually agreed terms.
The decision to deregulate loan rates follows the recommendations of an internal panel headed by executive director Deepak Mohanty. The panel’s report was opened for public comment in October, through 17 November.
Accepting some feedback from bankers, the central bank has permitted banks to charge differential rates of interest on scheme advances, loans to banks’ own employees and loans to banks’ depositors against their own deposits without reference to the base rate.