Base rate will replace BPLR from April 1

In a bid to improve transparency and uniformity in pricing of bank loans, the Reserve Bank of India (RBI) on Wednesday proposed linking lending rates to banks’ cost of deposits through a “base rate system” that will replace the prevailing benchmark prime lending rate (BPLR) system from April 1. The RBI issued a draft circular and said it proposes to ban lending below the base rate.

Currently, about 70% of banks’ loans are sub-PLR.  Bankers say once the new system comes into effect, the difference between banks’ lending rates will be 25-50 basis points.

Banks will have to set the base rate linking it to their deposit rates after factoring in overheads, profit margin and risk premium they seek, and negative carry for maintaining cash reserve ratio and statutory liquidity ratio.

Banks will set their actual lending rates as a spread over base rate.  Since, RBI will bar lending below the base rate, it will separately issue guidelines for banks’ export credit, which usually has softer terms.

Most banks welcomed the proposed base rate system, saying it will bring uniformity and end predatory pricing. The base rate system was based on the recommendations of an expert panel, which included bankers, set up to review BPLR system.

Bankers say the base rate system will help cut the arbitrage advantage some top corporate borrowers enjoyed. They say loans extended to larger companies lately have been under-priced and the volumes lent too have been very large.

The central bank has also been concerned with the extent of sub-PLR loans as it blurs 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 said the prevalence of a “borrowers market especially in short term-lending to large corporates” will not exist anymore as the rate will also be dependent on level of liquidity and cost of deposits.

Analysts said public-sector banks that have been looking at improving their CASA ratios and capital adequacy ratio especially in the aftermath of the global slowdown are likely to benefit most 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.

The actual lending rates charged to borrowers would be the base rate plus borrower-specific charges and will include product specific costs and credit risk premium and tenor premium.

Nayak said currently, most lending is below the bank’s effective base rate, indicating banks are cutting their profit and pricing loans lower than the actual risk premium.

According to the RBI, once the new system comes into effect from April 1, the current stipulation of BPLR as the ceiling rate for loans up to Rs 2 lakh stands withdrawn.