>Draft guidelines on base rate: Impact on banks (CRISIL)

The RBI has come out with a draft circular on the base rate, which is expected to substitute the current Benchmark Prime Lending Rate (BPLR) system with effect from April 1, 2010. The base rate would act as a minimum rate for all commercial loans, including loans up to Rs 2 lakhs where the BPLR currently acts as the ceiling rate.

CRISIL Research estimates the base rate for majority of the banks to be in the range of 8.0 to 9.5 per cent. Moving to a base rate system would increase transparency in lending rates. However, if the base rate were to become the minimum rate for all commercial loans, it would adversely affect the bank’s ability to extend short-term funding to large corporates.

The Reserve Bank of India has released a draft circular on the base rate, which is expected to substitute the current Benchmark Prime Lending Rate (BPLR) system with effect from April 1, 2010. Although final guidelines in this regard are awaited, the draft circular provides broad contours of the new base rate system.

Salient features of the base rate system:
1. The base rate system will replace the BPLR system from April 1, 2010 onwards.
2. Criteria for determining the base rate -

• Cost of deposits
• Adjustment for negative carry in cash reserve ratio (CRR) and statutory liquidity ratio (SLR)
• Unallocatable overhead cost for banks such as aggregate employee compensation relating to administrative functions in corporate offices, directors’ and auditors’ fees, legal and premises expenses, depreciation, cost of printing and stationery, expenses incurred on communication and advertising, IT spending, cost incurred towards deposit insurance
• Profit margin

3. The base rate will act as minimum rate for all commercial loans, including loans up to Rs 2 lakhs where the
BPLR currently acts as the ceiling rate.
4. Actual rate charged to borrowers would be the base rate plus borrower-specific charges, which will include
product specific operating costs, credit risk premium and tenor premium.
5. Base rate to be the reference rate, henceforth, for all new loans and for loans coming up for renewal. The
existing borrower could also shift to the new system on a mutually agreed rate structure between the borrower and the bank. Moreover, the base rate could act as a benchmark for floating rate loans.
6. Interest rates for Differential Rate of Interest (DRI) scheme loans will continue to be fixed without reference
to the base rate. RBI will separately announce the stipulation for export credit.
7. Banks would be required to exhibit information on base rate at all branches and post it on their respective
websites as well.

Impact on banks
CRISIL Research estimates the base rate for majority of banks to be in the range of 8.0 to 9.5 per cent. As of March 2009, around 67 per cent of outstanding advances by scheduled commercial banks (SCBs) were at sub-BPLR. Moving to a base rate system would increase transparency in lending rates. However, if the base rate were to become the minimum rate for all commercial loans, it would adversely affect the bank’s ability of extending short-term funding to large corporates. Currently, banks, saddled with surplus liquidity and lack of avenues to deploy funds, have been providing short-term loans to large corporates (with healthy credit profile) at rates as low as 5.5 to 6.0 per cent. Moving to the proposed base rate system would make it impossible for banks to provide loans at these rates, which, consequently, would lead to corporates considering alternative sources.

Background
A working group, under the chairmanship of Deepak Mohanty, was constituted to examine the lending rate practices of banks and subsequently, submit its recommendations on the same. The RBI’s guidelines (announced approximately 4 months later) are broadly in line with the recommendations of the working group.

The RBI, concerned about the sub-BPLR pricing of commercial loans by banks in India and the wide divergence in BPLRs of major banks, had constituted the working group to review the BPLR system and suggest changes to introduce greater transparency in credit pricing.

The working group was assigned to review and provide suggestions on the following:
1. Extent of sub-BPLR lending and reasons for the same
2. Wide divergence in BPLRs of major banks
3. An appropriate loan pricing system for banks
4. Administered lending rates for small loans up to Rs 2 lakh and for loans extended to exporters
5. Suitable benchmarks for floating rate loans in the retail segment
6. Consideration of any other issues relating to lending rates of banks

To read the full report: BPLR