Base rates will help make credit pricing transparent

The Reserve Bank of India (RBI) has been concerned about making credit pricing more transparent for quite some time now. One of the reasons being the widespread complaints by home loan consumers that lenders are quick to raise their benchmark prime lending rate (BPLR) when the regulator raises signalling rates (repo, reverse repo, bank rate, CRR and SLR) but lag behind considerably when the regulator drops these rates.

The working group constituted by the regulator for this purpose has submitted its report and RBI’s final decision is awaited.  This article seeks to examine if the “base rate” system recommended by the group is more transparent than the existing BPLR system.
The short answer to that question is “Yes”.

The base rate system is definitely more transparent than the BPLR system. But there are some non-transparent aspects to the fixation of the base rate, which need to be highlighted.

In simple words the “base rate” system recommends that the one year retail fixed deposit rate of a bank (after making certain adjustments) be the base rate for that bank and that floating rate loans be pegged with reference to such a base rate. The one year retail FD rate for each bank is easily and publicly available and to that much extent, it adds considerably to transparency.

It’s the adjustments, however, that are based on not-so-easily available information as well as complex to calculate. For the adjustments, consumers will still need to depend on the concerned bank to make them properly.

Having said that, any bank will find it really tough to explain why the base rate has not dropped if it decides to drop its one year retail fixed deposit rate. Some other issues with this mechanism also need mention.

First, no bank follows the existing regulations, which require that floating rate loans be priced with reference to a suitable external benchmark.

In fact, if this regulation  is followed, there is no need for any change in the regulation at all. This leads to justifiable concern among consumers whether any new regulations will be followed by the banks or whether the regulator will enforce any regulations that it chooses to notify in this regard.

Second, the group has left vague the applicability of the new base system to existing borrowers by stating “… if the existing borrowers want to switch to the new system before the expiry of the existing contracts, in such cases the new/ revised rate structure should be mutually agreed upon by the bank and the borrower.”

Here, consumers will agree it is nearly impossible to get the bank to agree on something like this. It would have been better if the modalities of applying the new system to the existing borrowers had been spelt out clearly.

Third, of course, is the enforceability of any new regulations. For any regulation to be effective, it needs to be monitored by the regulator; transgressions need to be penalised and repeat offenders need to be punished. Let’s therefore hope that if the regulator chooses to accept the group’s recommendation, then it will also be enforced vigorously.

The writer is CEO, Apna Paisa, a search comparison engine for loans, insurance and investments.