Bank loans will be based on base rate system from April 1

The Reserve Bank of India (RBI) wants to bring transparency and uniformity in pricing of bank loans therefore it has issued a draft circular in which it has stated that it plans to ban lending below the base rate. RBI plans to link lending rates to banks’ cost of deposits through a “base rate system” with the introduction of this system the existing benchmark prime lending rate (BPLR) will get replaced. It plans to introduce the new system from April 1.

At present 70% of loans given by banks are based on sub-PLR. According to bankers after the introduction of new system the difference between banks’ lending rates will be 25-50 basis points. Thus banks after taking into consideration their overheads, profit margin and risk premium they seek, and also the negative carry for maintaining cash reserve ratio and statutory liquidity ratio they will set the base rate linking it to their deposit rates.

Moreover banks plans to set their actual lending rates as a spread over base rate. RBI will be issuing separate guidelines for banks’ export credit - these usually have softer terms, as it will be banning lending below the base rate.

However RBI proposal has been welcomed by most of the banks. The banks say the new system will bring uniformity and bring end to predatory pricing. The base rate system will be based on the recommendations of an expert panel including bankers as its members. Panel was set up to review BPLR system.

Even the arbitrage advantage enjoyed by some top corporate borrowers will get reduced due to base rate system, say bankers. Recently the loans given to large companies were under-priced and the volume of loans was also very large.

The apex bank has also expressed concern over the extent of sub-PLR loans as it increases the transmission mechanism of its monetary policies.

“Banks will now be compelled to tap cost effective resources, improve operational efficiency, and include profit spread margin and risk premium along with the client’s credibility while determining the base rate. This will cut down on under-pricing of loans and bring uniformity in the system,” said M Narendra, executive director at Bank of India.

He added the occurrence of a “borrowers market especially in short term-lending to large corporates” will also get diminished as the rate will also be in accordance to level of liquidity and cost of deposits.

According to analysts public sector banks after the global slowdown have been trying to improve their CASA ratios and capital adequacy ratio are going to be benefited most from this new system as their cost of deposits will be lower

“The difference between banks base rate will not be more than 25-50 basis points so the borrowers cannot arbitrage between banks as rates almost common, bringing more stability into interest rates,” said M R Nayak, executive director at Allahabad Bank.

Under new system the actual lending rates charged from borrowers will be the base rate plus borrower-specific charges and will include product specific costs and credit risk premium and tenor premium.

Nayak said at present most of the lending is done below the bank’s effective base rate, which signifies that banks have been cutting their profit and pricing loans lower than the actual risk premium.

As per the RBI circular, after the introduction of the new system from April 1, the current condition of BPLR as the ceiling rate for loans up to Rs 2 lakh will come to an end.