>RBI TO REPLACE BPLR (BENCKMARK PRIME LENDING RATE) SYSTEM WITH BASE RATE FROM 1 APRIL, 2010

Event: RBI introduces Base rate to replace BPLR
The RBI has decided to replace the prevailing BPLR (Benchmark Prime Lending Rate) system with a new Base rate for all scheduled commercial banks. This base rate system would be effective from 1st April, 2010.

As per the draft circular by RBI, all lending rates would be determined with reference to the base rate which shall be common across all categories of borrowers. The actual lending rates 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.

Each bank is free to decide its own base rate; though following criteria could be used:

1. cost of deposits
2. adjustment for the negative carry in respect of CRR and SLR
3. unallocable overhead cost for banks
4. average return on networth

Banks would not be allowed to resort to any lending below base rate.
The base rate system would be applicable for all new loans and for those old loans that come up for renewal. However, if the existing borrowers want to switch to the new system before the expiry of the existing contracts, in such cases the revised rate structure should be mutually agreed upon by the bank and the borrower.

Banks are required to provide information on the actual minimum and maximum lending rates charged to major categories of borrowers to the RBI on a quarterly basis.

Earlier, RBI had constituted a Working Group on BPLR to review the BPLR system and suggest modifications to increase transparency in credit pricing. The committee had suggested replacing the BPLR system with a new Base Rate system. Going ahead with the committee’s recommendations, the RBI has come out with the present policy moves.

Impact
■ Short-term rates for large corporates might inch up
Ample liquidity and relatively subdued credit demand over FY10 had led to many large corporates borrowing at significantly low rates. Application of the illustrative formula (as provided by the RBI) to most banks reveals that base rates could vary between 8% to 9.5% (see Annexure). With most banks setting their base rates around these levels, we believe that shortterm rates for large corporates could inch up.

■ Teaser rates would come under pressure
RBI has taken a negative view of the recent “teaser rate” schemes launched by major banks. RBI expects banks to be more prudent in pricing the risk and do not lose sight of asset quality while chasing market share (in wake of subdued credit demand). We believe that such “teaser rate” schemes would come under pressure as base rates are expected to higher than the rates offered on such schemes.

Our view
■ Increased transparency on lending rates
Over Oct-08 to Dec-09, while banks’ cost of deposits declined significantly, the movement in BPLR’s was relatively less and did not adequately reflect the effective lending rates in the economy. Moreover, ample liquidity in the system and the subdued demand for bank credit had increased the competitive pressure on banks to lend at sub-BPLR rates. As a consequence, the BPLRs of banks have turned out to be the maximum lending rates in most cases, distorting the information content.

■ Faster transmission of policy rate changes
We believe the base rate system has directly linked headline lending rates in the economy to banks’ cost of deposits. The RBI, over the past 3-4 quarters, had repeatedly sounded concern that while transmission of policy rate changes (over Sep-08 to Apr-09) had been faster in the money and government securities markets, it had been slow to the banks’ lending rates.

The RBI’s present action is to encourage faster transmission of policy rate changes to banks’ lending rates as the base rate would be directly linked to banks’ cost of deposits.

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