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INDIAN BANKING: The New Guideline: Introducing the Base rate (FIRST GLOBAL)

RBI’s micro-management moves and their likely impact on bank margins

Shift in credit pricing from Benchmark Prime Lending Rate (BPL R) to Base Rate as minimum lending rate for banks…

Teaser home loan rates come to an end…Margins of banks, particularly PSBs, to come under strain


The Reserve Bank of India (RBI) has decided to take a more activist (or micro-management) role in management of banks including the pricing of credit facilities and the calculation of interest on deposits. A series of moves it has undertaken to this end will have significant implications for the banking sector, from margins to relative competitive positioning of banks. The RBI recently released a draft circular that provided new guidelines for increasing transparency in credit pricing, wherein the Benchmark Prime Lending Rate (BPLR) will be replaced with the Base Rate from April 1, 2010 or FY11. This marks a significant development for the Indian banking industry, as it will change the way banks calculate their lending rates and sub-PLR lending will now come to an end. Presently, there exists a wide disconnect between the BPLR and actual rates For instance, the actual lending rate for Public Sector Banks (PSBs) in September 2009 stood at 4.25- 18%, as against a BPLR of 11-13.5% for the same period. The same pattern existed for Private sector banks and Foreign sector banks as well. Thus, the BPLR failed to represent the actual lending rates, as well as respond to the changes in monetary instruments (a decline of 275-425 bps in the policy rates was followed by a lower than proportionate decline in the BPLR of public, private and foreign sector banks. PSBs reduced their BPLR by 150-275 bps, which was higher than that of its counterparts, partly due to the moral pressure exerted by the Central Bank). Once banks calculate their base rate according to the method recommended by the Working Committee on BPLR (Chairman: Shri Deepak Mohanty) (as shown in the illustration attached in the Annexure), the rate will work out to around 8-9% for a majority of the banks. This could make the base rate more responsive and ensure transparency in credit pricing.

To our mind, banks that have a higher proportion of CASA deposits, lower costs as a percentage of assets, and are technologically upgraded, are likely to have a lower base rate, thus enabling them to price their loan products more competitively. Big banks that enjoy economies of scale could increase their business at the cost of some inefficient and small banks. On the home loans front, teaser home loan rates are likely to be withdrawn by the end of FY10, though the margins of banks, particularly PSBs, will come under strain. Moreover, the regulatory requirement for providing interest on savings deposits on a daily balance basis will come into effect from FY11, which will lead to an increase the interest expenses of banks. That said, the RBI has actually gone for micro management of the banking industry and full implications of its move will be clear only after the finer details of the circular is released. Also, it remains to be seen what mechanisms the market throws up to counteract the RBI’s push to banks to move towards a what is essentially a ‘cost-plus’ model. We do not rule out unintended consequences coming into play here.

The New Guideline: Introducing the Base rate

■ Intended Purpose: To increase transparency in credit pricing and address the shortcomings of the BPLR system

■ The Guidelines: The base rate is proposed to be calculated by including the cost of deposits, cost of maintaining the statutory liquidity ratio and cash reserve ratio, cost of running the bank, and profit margin. This will be the minimum lending rate for banks. Hence, the actual rate will depend upon the base rate plus borrower specific charges, which will include product specific operating costs, credit-risk premium, and tenure premium. Moreover, the guidelines direct banks to disclose their base rate on a quarterly basis and ensure that the interest rates charged to the customers are non-discriminatory in nature.

■ Expected Outcome: The RBI expects an increase in credit flow to small borrowers at reasonable rates at the current stipulation of BPLR, as the ceiling rate for loans up to Rs.0.2 mn has been withdrawn. Also, the base rate of banks will now decline to the single digit (as shown in an illustration by the working committee group using data for FY09, the base rate works out to 8.55%).We have attached the Illustration of the base rate calculation in the Annexure.

To read the full report: INDIAN BANKING

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