Are base rates headed the BPLR way?

The much awaited base rate system, aimed at imparting much needed transparency to the pricing of floating rate loans, took effect in July 2010.

One of the key features of the base rate system was that it would be fixed based on a pre-defined formula and the base rate would change from time to time (at least once every quarter) based on the changes in the value of the parameters in the formula. This formula was supposed to be shared with and audited by the Reserve Bank of India (RBI) to make sure the bank continued to follow the formula on a consistent basis.

RBI has also granted banks flexibility to change the formula during the transition period till December 31, after which it is supposed to remain constant.

We have already seen a rise in the base rates of various banks (see table) this month.

Whilst an increase in the base rate was expected given the increase in deposit rates during the quarter, it is mystifying how such an increase in nice round numbers such as 0.25% or 0.50% (if a specific formula was being used, it would have been odd figures such as 0.23% or 0.27%). If rounding off to the nearest 0.25% is part of the formula, one only hopes that the banks will use the same logic when the interest rates decline sometime in the future. If the increases are in round sums because a revised formula has been used by the banks then, in the interest of transparency, that fact should be disclosed. In fact, the non-disclosure of the formula by the bank defeats the whole purpose of transparency.

Today, the only major thing that gives hope that the base rate regime will be better than the earlier benchmark prime lending rate (BPLR) system is that banks are not allowed to lend below this rate to anybody (except for a very small list of loans which are not significant). So when general interest rates fall (appears some distance away at this moment) it is likely to put pressure on at least those banks that want to lend monies to blue chip corporates to reduce their base rates if they want to continue to lend to those blue chip borrowers. This of course will be much less of a pressure point for banks which are not serious players in the blue chip lending market. So if the blue chips find a way of getting around these restrictions on minimum lending rates, then whatever little pressure exists today for lowering of base rates will also disappear.

So the only solution is to make sure the base rates are fixed transparently as per a publicly disclosed formula to ensure wide spread acceptance of the transparency of the process.

It is quite possible that the RBI is waiting for the transition period till December 31, 2010 to be overbefore making the formula public, to enhance transparency. This is the only way to change the widely
held public perception that lenders are quick to raise rates when policy rates rise but are extremely reluctant to drop rates when the policy rates drop.

The writer is CEO, Apna Paisa, a price & features comparison engine for loans, insurance and investments. He can be reached at hrdna@apnapaisa.com.