Mumbai: Companies and individuals will have to pay more interest on their loans with banks planning to raise their rates following the hike in the Reserve Bank of India’s (RBI) policy rates, the fifth such since March. RBI has raised the rate at which it lends to banks by 25 basis points (bps) to 6% and the rate at which it borrows from them by 50 bps to 5% to tame inflation. One basis point is one-hundredth of a percentage point.

Bankers expect all loan rates, including those on mortgages, and car, personal and education loans, to go up from October even though very few of them are willing to commit on the quantum of the hike at this point.

Banks will hike their base rate, or the floor rate for all loans, but the prime lending rate (PLR), the rate reserved for their best customers, could remain unchanged—for now.

Also See Expected Move (PDF)

The base rate system, introduced in July, replaced the old PLR regime, but old loans are still linked to that benchmark.

The base rate for most banks is 7.5-8.5%. PLRs, in contrast, range between 11.75% and 16%.

“There is a strong possibility that our base rate will go up by 0.25 percentage point," said Bank of Maharashtra chairman and managing director Allen Pereira. “The RBI action is a signal that cost of funds and loan rates will go up."

Only recently, most banks increased PLR by around half a percentage point and deposit rates by 25-50 bps across maturities. As the main component of the base rate is deposit rates, it is already under pressure for an upward revision, irrespective of RBI’s latest rate action, said IDBI Bank Ltd’s executive director R.K. Bansal.

The method for calculating the base rates varies among banks, but the cost of deposits is the key input for all formulae.

RBI is goading banks to raise their deposit rates as real returns on deposits have turned negative because of higher inflation rates. Wholesale price-based inflation stood at 8.5% in August, but one-year bank deposits still pay only between 6.75-7%.

Kotak Mahindra Bank Ltd’s treasurer Mohan Shenoi said banks will have to take a look at their deposit rates as the interest rate on employees’ provident fund (EPF) is set to go up from 8.5% to 9.5%. Bank deposits compete with EPF in some instances as employees in the organized sector can contribute more than the mandated 12% of their basic pay and dearness allowance to the fund instead of keeping their savings in bank deposits.

“By the end of September, we will have an idea of the impact on the cost of funds," said B.A. Prabhakar, executive director of Bank of India. “Lending rates in the banking system are likely to go up by end-October in line with the rise in overall cost of deposits." He doesn’t expect rates to move up immediately.

India’s oldest mortgage financing company Housing Development Finance Corp. Ltd (HDFC), too, is not in a hurry to hike its rates. “Our existing rates on the home loans will continue till the month-end and we will take a call after that," said Keki Mistry, its vice-chairman and managing director. HDFC raised its home loan rates early this month.

Foreign and private banks could be first movers in rate hikes.

“We expect a pretty immediate impact on lending rates, including in base rates by 0.25-0.50 percentage point," said Citibank’s chief financial officer Abhijit Sen.

Both Bank of Baroda chief M.D. Mallya and Canara Bank chief S. Raman said their banks have not decided on any rate actions as yet, but they see an “upward bias" in lending and deposit rates.

S.S. Ranjan, chief financial officer of the country’s largest lender, State Bank of India, said, “There may not be an immediate impact on lending rates as the monetary policy transmission happens with a lag," but any rise in lending rates will be a function of the liquidity conditions in the market and the pickup in credit demand.

The year-on-year loan growth for the banking industry till 27 August was 19.4%, higher than last year’s 14.1% and close to the RBI target of 20%, but the bulk of this was accounted for by telcos, which used the money to pay the government for third-generation spectrum and broadband licences. Very little money has gone to other sectors.

The yield on 10-year bonds closed at 7.96% on Thursday, marginally up from Wednesday’s close. Bond dealers do not expect any dramatic rise in yield. “It looks like the earlier hikes are beginning to bear fruit. The concerns of further aggressive rate hikes are moderating," said Phani Shankar, head of financial markets at ING Vysya Bank Ltd.

In New Delhi, finance minister Pranab Mukherjee said RBI’s move was “in the right direction" and Planning Commission deputy chairman Montek Singh Ahluwalia said it would not affect economic growth.