THE RBI panel headed by Deepak Mohanty has released a report regarding a base lending rate, which will replace the Benchmark Prime Lending Rate (BPLR). The RBI has put forth its recommendation on its website and is expected to take a stance on this very soon.

Why such a move?
The RBI believes the existing BPLR system has lost its relevance as a reference rate because loans are currently being provided below BPLR, which fall into the sub-BPLR category. This is an obstacle for smooth transmission of money.

There is a dire need for a system to be in place for a transparent loan pricing system. The BPLR was expected to keep such checks and monitor money outflow but with banks providing loans below BPLR, it is a moot point. So, the RBI plans to implement a base rate below which lending is not possible. As banks will need to add their operational costs to the base rate for lending, the rates could vary across segments and banks.

What does this mean for the borrower?
Under this proposed plan, banks will declare a base rate below which they cannot lend and above which interest rates will be charged depending on the individual credit profile and the loan tenure.

The base rate will do away with BPLR and include all the cost factors that are common to every borrower. This would be significant as the base rate will now be the benchmark for all floating interest rate loans. The only exception to the rule is for loans with tenure of less than one year or for priority sector advances. For these interest rates can be quoted below the base rate. On the other end, education loans that fall within Rs 4 lakh are to be capped at 200 basis points above the average base rate of the five largest banks.

Also read: Excess cash - keep as savings or prepay loan?

Good news for the existing borrower!
The base rate will be applied for new loans as well as loans that come up for renewal. Which means the existing borrower will now have the option to switch to the new terms if it suits him.

To ensure consistent transparency going forward, the banks are expected to release their base rate once in three months and also share the minimum and maximum lending rates with the approval of their concerned boards.

How is it expected to work?
The interest rate that is finally passed on to the borrower will now be X per cent plus or minus the base rate depending on his credit profile and other loan eligibility factors.

A comparative example:
In the BPLR scenario, suppose Suresh took a home loan at a floating rate of BPLR minus 2 per cent at a time when the bank’s BPLR was 9 per cent. The floating rate of 7 per cent that he received was attractive and it seemed to be the right decision to choose this loan.

Over time the BPLR of the bank increased to 15 per cent and Suresh’s floating rate became 13 per cent. However, Suresh’s bank is now offering a floating rate of BPLR minus 3.5 per cent to new customers, which means that new customers are paying a rate of 11.5 per cent, while Suresh is stuck with an interest rate of 13 per cent.

The irony of this situation is that Suresh signed up for a floating rate knowing that his rate would increase or decrease according to market conditions, not realising that his bank has the power to not share the benefit of a falling rate with him.

Now, it will be different if the base rate is in place.
First, Suresh would not get an interest rate below the base rate. So if the base rate is 9 per cent, depending on other factors in his credit profile, let's assume he has a floating interest rate of 11 per cent.

Suppose, owing to market conditions, the bank decides to lower its base rate after a few years to 7 per cent, Suresh has the option to pay the remainder of his loan at an interest rate much closer to 7 per cent, say at 9 per cent. However, in the earlier scenario he probably has to change banks and get a home loan transfer to enjoy the benefits of the new base rate.

Also read: Own a house jointly, get tax benefits

Illustration: Vaibhav Shirke



Abitha Deepak is Head of Content & Research at BankBazaar.com - An online marketplace where you can instantly get loan rate quotes, compare and apply online for all your personal loan, home loan and credit card needs from India's leading banks and NBFCs.

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