New Base Rate system - Trying to bring Transparancy in lending Rates

Ever wondered how banks decide interest rates to be charged on different loan products they offer? There has always been a widespread feeling that Indian banks do not have any transparent system to price their different loan products and they try to cross subsidize one business vertical to other and it is not linked to actual risk factors associated with that. In simple terms Mr. X will pay higher interest so that Mr. Y can pay lessor. To address this, In November, 2003, RBI brought in the concept of BPLR which stands for Benchmark prime lending rate. Every bank is free to fix its BPLR depending upon its cost of funds and various other factors. This was supposed to play a role of reference rate which would be used to price the lonas. Banks were supposed to price their Loans on BPLR plus some margin depending upon the risk characteristics of particular product.

Why BPLR system replaced by Base rate system?

very simple, it failed to serve the purpose it was brought in. Most of the banks still lent money at a sub BPLR rates. calculation procedure was also very vague thus every banker had their own methods of calculating BPLR

New Base Rate system


while the objective of RBI was same this time also. emphasis was to address all those issues because of which BPLR system failed to play its supposed roles. Main Difference is how to calculate base rate. unlike BPLR system which was not transparent, calculation of Base rates all those cost elements which can be directly identified and are common across all borrowers. Essentially, New calculated Base rate will represent the bare minimum rate below which lending will be clearly inviable for banks.

Implication of New Base Rate System

• Bringing Transparency: Displaying Base rate will be mandatory at all branches of bank. Any changes in base rates need to be communicated to common public immediately.
• Big "No" to cross -subsidization: Banks generally tend to cross subsidize Big corporate loans at the expense of retail borrower. This practice will stop now.
• Loan against FD: Generally Banks provide Loans against FDR issued by them by charging just 1 or 2 % more than the FDR interest. But once Base Rate system in place, this practice will stop. So it will be big impact on small businessman who usually draw temporary loans against their FD.
• No More Teaser Rate Loans: New Base Rate system shall effectively stop the practice existing in home loan segment i.e issuing Loans at Teaser rates. Home Loans which have very artificially low rates for initial years.

To sum up, We can expect a positive change will happen in Indian Banking system if this new system is applied in its true spirit.