A WORKING group, set up to find ways to bring about transparency in the banks, published this report on the RBI website in October 2009 to get feedback from the public. After evaluating the report, the RBI has come up with guideline recommendations for banks to adhere to with effect from April 2010.

Objective
Interest rates play a very crucial role and are critical to the rise and fall of the economy. Interest rates veering too high or dipping too low can spell trouble and can become a cause for concern for credit quality and financial stability. To avert any possibility of such a disaster, they need to conform to changes in the monetary policy.

The base rate and its backdrop
RBI has recommended that the Benchmark Prime Lending Rates (BPLR) system be replaced by a base rate system below which no lending can be done.
Reason: The BPLR system failed to achieve what it was originally intended for – transparency in lending rates charged by banks.

The report indicates that the BPLR does not have a bearing with the existing market conditions and is not responsive to changes effected in the monetary policy in the current system. The group also discovered the larger percentage of loan disbursals were at sub-BPLR rates, which was a bottleneck for establishing transparency.

Banks are expected to decide on their actual lending rates using the base rate as a reference from April. The actual lending rate decided on individual basis takes into account the base rate plus charges specific to the individual borrower based on his credit profile, loan eligibility and other criteria relevant to lending norms practiced by the banks. This can only be equal to or above the base rate and never below it as per the recommendation.

On the other hand, the Base rate is expected to take into account all the elements of lending rates, which are common across different segments of borrowers. Banks can come up with their own base rate but need to factor in various aspects like deposit rates, mandatory cash requirements, profit margins, and other bank specific factors.

What is expected to change?
- All external aspects with relevance to the current BPLR system will still prevail in the base rate regime. There will still be scope for more trend setting loan schemes like the Teaser home loan schemes.

- Existing borrowers and new borrowers may still have a certain degree of difference in their respective lending rates. This concern is being taken up by the RBI in a separate process with the Indian Banks Association (IBA) who are not very inclined to reverse the existing loan rates to the base rate system, which is expected to come into effect this April. IBA feels that such a move could have a negative impact on banks' earnings.

- Banks will announce the rate changes on their bank websites as and when it happens. This would ensure transparency, and create more awareness.

Read: Ways to improve your credit score

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.

e-mail: Abitha Deepak

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