Base rate, the new benchmark system for pricing loans, has been implemented by banks from 1 July. This marks the end of the benchmark prime lending rate (BPLR) regime, which was particularly unsuited to retail borrowers.
While banks were quick to raise rates every time the central bank hiked them, the reverse did not happen. The base rate, say experts, will give even the existing borrowers the option to shift to lower rates.
THE NEW STRUCTURE Base rate is the minimum rate at which banks can lend (barring specified exemptions, such as to export and agricultural sectors). According to the RBI guidelines, it is calculated on the basis of the cost of deposits.
This will also compensate the banks for the money they lose in maintaining the cash reserve ratio and the statutory liquidity ratio because this can now be included in the deposit costs. A premium will be added to the base rate to account for the unallocated costs of running the bank and an estimated profit margin. This formula is more transparent than the BPLR, which was not linked to any parameter in particular.
WHAT WILL CHANGE? The first change is that all loans, including home, personal and education loans, will be pegged to a single rate. While, earlier, banks had separate BPLRs for retail and corporate loans, now all borrowers will consider only the base rate. Also, the transmission of policy guidelines, such as lowering of rates, is expected to be much faster in the new regime.
For instance, if a home loan is pegged at base rate plus 4% and the bank brings down its base rate, the benefit will pass on to the existing borrower. In fact, this was one of the main reasons for introducing the base rate. An RBI panel had recommended the new system in October 2009 after it found that most private sector banks were not passing on the reduction in policy rates to customers. This was especially evident in case of home loans. However, for the existing borrowers, whose loans are pegged to the BPLR, shifting to the base rate may not be easy. For one, most bankers feel that banks will not take the initiative to inform customers about this option. The good news is that the RBI has asked banks not to charge the borrowers for the shift.
WHAT WILL NOT CHANGE
Whether it is the base rate or the BPLR, it won't help to compare interest rates of two banks. The reason is that the base rate is just a benchmark, not the rate at which you get the loan.
The lending rate depends on the risk premium, based on the borrower's credit worthiness, and the risk of the venture being financed. The borrower will also continue to benefit from teaser rates under the new system.
In fact, SBI has already extended its teaser rates till September, and HDFC Bank has done so till March 2011. When the existing borrowers shift to the base rate system, the interest rate they pay is unlikely to change significantly as banks will add overheads, such as risk premiums, to take it to the original level. "Banks have the flexibility to control other loan-pricing elements, including tenor and credit risk premiums, as well as product-specific operating costs. This will provide them with some cushion to protect their interest spreads," says Suman Chowdhury, head, Crisil Ratings.
The benefit of shifting will be evident if the base rate comes down. A low base rate is also not expected to have borrowers flocking to the bank that quotes the lowest rate. This is because a bank's capacity to service loans is based, among other things, on its deposits. So, even if everyone wants to go to a particular bank, it may not be able to accommodate them. WHAT YOU SHOULD DO If you are an existing borrower, shift to the base rate structure.
However, if you are planning to take a loan, don't go by the base rate alone and consider other factors, such as customer service and branch proximity.
Even the base rate differential for many banks may change soon as interest rates are expected to go up in the short term. "Interest rates have already started hardening. They are likely to rise by at least 0.5% over the next six months considering the present liquidity scenario and the upward inflationary pressure," says HDFC chairman Deepak Parekh.
In fact, wait till 30 September, when banks will get a chance to revise their base rates. The new system is a step towards making lending transparent. Hopefully, it will also translate into simpler loan documentation.
