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Base Rate
CHAPTER 1
RESERVE BANK OF INDIA
____________________________________________________
1.1 OBJECTIVES OF THE RESERVE BANK OF INDIA
1.2 ORGANIZATION AND MANAGEMENT OF RBI
1.3 FUNCTIONS OF THE RESERVE BANK OF INDIA
1.4 MONETARY POLICY OF INDIA
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CHAPTER 1
RESERVE BANK OF INDIA
1.1
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a. The Preamble
objectives of the Reserve Bank as: to regulate the issue of Bank notes and
the keeping of reserves with a view to securing monetary stability in India
and generally to operate the currency and credit system of the country to its
advantage.
b. Prior to the establishment of the Reserve Bank, the Indian financial system
was totally inadequate on account of the inherent weakness of the dual
control of currency by the Central Government and of credit by the Imperial
Bank of India.
c. The Hilton-Young Commission, therefore, recommended that the dichotomy
of functions and division of responsibility for control of currency and credit
and the divergent policies in this respect must be ended by setting-up of a
central bank called the Reserve Bank of India which would regulate the
financial policy and develop banking facilities throughout the country.
Hence, the Bank was established with this primary object in view.
d. Another objective of the Reserve Bank has been to remain free from
political influence and be in successful operation for maintaining financial
stability and credit. The fundamental object of the Reserve Bank of India is
to discharge purely central banking functions in the Indian money market,
i.e., to act as the note- issuing authority, bankers bank and banker to
government, and to promote the growth of the economy within the
K.E.S College of Arts & Commerce
Base Rate
1.2
a. The RBI is managed by the Central Board of Directors, four Local Board of
Directors and the Committee of the Central Board of Directors. The Local
Boards advise the Central Board on such matters as are referred to them.
They are also required to perform the duties which are delegated to them.
The final control of the RBI vests in the Central Board which comprises the
Governor, four Deputy Governors and fifteen Directors nominated by the
Central Government. The Committee of the Central Board consists of the
Governor, the Deputy Governors and other Directors as may be required to
be present in the meeting.
b. The Reserve Bank of India has local Boards with headquarters at Mumbai,
Kolkata, Chennai and New Delhi. Local Boards consisting of five members
and these members are appointed by the central government as far as
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c. The Chairman of the Central Board of Directors of the RBI is called the
Chief Executive Authority of the Bank and he is known as the Governor.
The Governor has the powers of general superintendence and direction of
the affairs and business of the bank. He is authorized to exercise all powers,
which may be exercised or done by the bank. In the absence of the
Governor, the Deputy Governor nominated by him in this behalf exercises
his powers.
1.3
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The Reserve Bank of India performs all the typical functions of a good Central
Bank. In addition, it carries out a variety of developmental and promotional
functions attuned to the course of economic planning in the country. The RBI
performs almost all traditional central banking functions. It functions within the
framework of mixed economic planning. The legal, economic and institutional
factors have rendered the issue of the independence of the central bank almost
irrelevant. It has to maintain close and continuous collaboration with the
government while framing various policies. The following functions are carried
out by the RBI.
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The Central Government has to entrust the bank all its money, remittance,
exchange and banking transactions in India and deposit all its cash balances
with the Reserve Bank. Reserve Bank also performs similar functions on
behalf of the State Governments. The RBI has entered into agreements with
the central and state governments for carrying on these functions. Thus, the
RBI accepts money on account of the governments, makes payment on their
behalf and carries out other banking transactions such as exchange and
remittances.
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all the members of the IMF. The RBI administers the exchange control in
terms of the Foreign Exchange Regulation Act, 1973.
Agricultural Finance.
The Agricultural Credit Department of the Reserve Bank is an unique
example of central banks of developed countries. When the integrated
Scheme of agricultural credit was implemented, the RBI assumed certain
new responsibilities and with it there was a clear transformation in the role
of RBI from that of a lender of last resort to that of an active agency for the
promotion of appropriate specialized agencies of agriculture finance. Major
functions of the Agriculture Credit Department of the Reserve Bank were
taken over by the National Bank for Agriculture and Rural Development
(NABARD) from July, 12, 1982.
Credit Control:
The Principal function of a central bank is credit control. Reserve Bank of
India exercises control over the credit granted by the commercial banks in
the following manner:
o
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Industrial Finance
Export Finance.
Institutional promotion.
1.4
a. The Monetary and Credit Policy is the policy statement, through which the
Reserve Bank of India seeks to ensure price stability for the economy. These
factors include - money supply, interest rates and the inflation. In banking
and economic terms money supply is referred to as M3 - which indicates the
level (stock) of legal currency in the economy.
b. Besides, the RBI also announces norms for the banking and financial sector
and the institutions which are governed by it. These would be banks,
financial institutions, non-banking financial institutions and primary dealers
(money markets) and dealers in the foreign exchange (forex) market. The
Monetary Policy has become dynamic in nature as RBI reserves its right to
alter it from time to time, depending on the state of the economy.
c. However, with the share of credit to agriculture coming down and credit
towards the industry being granted whole year around, the RBI since 199899 has moved in for just one policy in April-end. However a review of the
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policy does take place later in the year. The Monetary Policy regulates the
supply of money and the cost and availability of credit in the economy. It
deals with both the lending and borrowing rates of interest for commercial
banks.
d. The Monetary Policy aims to maintain price stability, full employment and
economic growth. The Reserve Bank of India is responsible for formulating
and implementing Monetary Policy. It can increase or decrease the supply of
currency as well as interest rate, carry out open market operations, control
credit and vary the reserve requirements. The Monetary Policy is different
from Fiscal Policy as the former brings about a change in the economy by
changing money supply and interest rate, whereas fiscal policy is a broader
tool with the government.
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e. The Fiscal Policy can be used to overcome recession and control inflation. It
may be defined as a deliberate change in government revenue and
expenditure to influence the level of national output and prices. For instance,
at the time of recession the government can increase expenditures or cut
taxes in order to generate demand. On the other hand, the government can
reduce its expenditures or raise taxes during inflationary times. Fiscal policy
aims at changing aggregate demand by suitable changes in government
spending and taxes. The annual Union Budget showcases the government's
Fiscal Policy.
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become crucial and there are concerns relating to credit flows to the
agricultural sector and small-scale industries. Instruments of Monetary
Policy in India:1. Net loans to central government (i.e. open market operations)
2. Net purchase of foreign currency assets
3. Change in cash reserve ratio
4. Changes in repo rate and reverse repo rate
5. Bank rate
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Base Rate
CHAPTER 2
BASE RATE AND ITS CALCULATIONS
____________________________________________________
2.1 INTRODUCTION
2.2 WHAT IS BASE RATE?
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Base Rate
CHAPTER 2
BASE RATE AND ITS CALCULATIONS
2.1
INTRODUCTION
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Base Rate
rate of 4.0 per cent per annum, and Export Credit, which was subject to an
entirely different regime of lending rates supplemented by interest rate
subsidies, the existing lending rate structure was continued.
D. An objective of financial sector reform has been to ensure that the financial
repression inherent in administered interest rates is removed. Accordingly,
in the context of granting greater functional autonomy to banks, effective
October 18, 1994, it was decided to free the lending rates of scheduled
commercial banks for credit limits of over Rs. 2 lakhs for loans up to Rs. 2
lakhs it was decided that it was necessary to continue to protect these
borrowers by prescribing the lending rates and accordingly it was
prescribed that for loans up to and inclusive of Rs.2 lakh, the lending rates
of banks should not exceed the BPLR of the respective banks. For credit
limits of over Rs.2 lakh, the prescription of minimum lending rate was
abolished and banks were given the freedom to fix the lending rates for
such credit limits subject to BPLR and spread guidelines. Banks were
required to obtain the approval of their respective Boards for the
Benchmark Prime Lending Rate (BPLR), which would be the reference
rate for credit limits of over Rs.2 lakh. Each bank's BPLR has to be
declared and be made uniformly applicable at all branches.
E. The BPLR system, introduced in 2003, fell short of its original objective of
bringing transparency to lending rates. This was mainly because under the
BPLR system, banks could lend below BPLR. For the same reason, it was
also difficult to assess the transmission of policy rates of the Reserve Bank
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Base Rate
F. The introduction of base rate will ensure that if they are linked to it, they
will see automatic rise and fall in their existing rates. The Reserve Bank of
India has asked banks not to charge any fee for shifting from prime lending
rate to base rate. Importantly, even though banks are going to charge a fee
in excess of 1.5 per cent in most cases for renegotiating the loan, it
could still make sense in doing so. Once you have shifted to the latest rate,
this along with the linkage with base rate will ensure that future costs are
saved. The PLR regime was stickier. Banks took a longer time to align
PLR with the interest rate movements. However, only home loan rates will
be impacted by this. All other retail loans, like auto and personal, are given
at fixed interest rate.
G. From July 1, banks will move to a new, more transparent regime of loan
pricing. They will jettison the Benchmark Prime Lending Rate (BPLR) and
price loans off a base rate.
H. Unlike the BPLR that was set somewhat arbitrarily by banks, the base rate
will follow an explicit formula that factors in a banks cost of deposits,
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Base Rate
operating costs (expenses of running its branches, for instance), the cost of
statutory drafts on bank funds imposed by the Reserve Bank of India (the
Cash Reserve Ratio and Statutory Liquidity Ratio) and the profit margin.
I. The base rate will help borrowers to compare interest rates offered by
various banks and make the process of how banks arrive at interest rates for
loans more transparent.
J. RBI has stipulated that banks cannot charge below the base rate for most
loans. (There are a couple of exceptions like agricultural loans and export
credit.) While the new model will ensure greater transparency, it need not
mean lower lending rates for borrowers.
K. In fact, banks blue-chip corporate borrowers could see some increase in
their cost of borrowing. The reason is somewhat simple. RBI allowed
banks to lend below their prime lending rates and the majority of banks did
the bulk of their corporate lending at sub-PLR rates.
L. The new reference rate for countrys largest bank is 7.5 per cent. Most of
the other public sector banks have the base rate at 8 per cent. These
include, IDBI Bank, Indian Bank, Bank of Baroda, Allahabad Bank and
Punjab National bank. HDFC Bank has set the rate at 7.25 per cent.
M. The best credits for a bank could drive the hardest bargains. This led to
peculiar situations in which a bank whose official BPLR was in the range
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Base Rate
of 14-16 per cent was found lending to its best customers way below its
costs at 5-6 per cent.
N. The incentive for this irrational pricing was to keep the ratio of nonperforming assets low, particularly in the wake of the global financial crisis
when banks risk appetite waned and safety got precedence over margins.
The base rate regime does away with this.
2.2
A. The Base Rate system, replace the BPLR system with effect from July 1,
2010. For loans sanctioned up to June 30, 2010, BPLR will be applicable as
given in Annex2. However, for those loans sanctioned up to June 30, 2010
which comes up for renewal from July 1, 2010 onwards, Base Rate would be
applicable. Base Rate shall include all those elements of the lending rates
that are common across all categories of borrowers. Banks may choose any
benchmark to arrive at the Base Rate for a specific tenor that may be
disclosed transparently. Banks are free to use any other methodology, as
considered appropriate, provided it is consistent and are made available for
supervisory review/scrutiny, as and when required.
B. Banks may determine their actual lending rates on loans and advances with
reference to the Base Rate and by including such other customer specific
charges as considered appropriate.
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Base Rate
C. In order to give banks some time to stabilize the system of Base Rate
calculation, banks are permitted to change the benchmark and methodology
any time during the initial six month period, i.e. end-December 2010.
D. The actual lending rates charged should be transparent and consistent and be
made available for supervisory review/scrutiny, as and when required. There
can be only one Base Rate for each bank. Banks have the freedom to choose
any benchmark to arrive at a single Base Rate which should be disclosed
transparently.
E. Even after introduction of the Base Rate system, banks would have the
freedom to offer all categories of loans on fixed or floating rates. Where
loans are offered on fixed rate basis, notwithstanding the quarterly review of
the Base Rate, the rate of interest on fixed rate loans will continue to remain
the same subject to the condition that such fixed rate should not be below the
Base Rate.
2.3
A. With effect from July 1, 2010, all categories of loans should be priced only
with reference to the Base Rate.
However, the following categories of loans could be priced without
reference to the Base Rate: (a) DRI advances (b) loans to banks own
employees (c) loans to banks depositors against their own deposits.
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(i)
(ii)
has
already
been
clarified,
vide
our
circular
DBOD.Dir.
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B. Restructured Loans
b. The Base Rate could also serve as the reference benchmark rate for floating
rate loan products, apart from external market benchmark rates. The floating
interest rate based on external benchmarks should, however, be equal to or
above the Base Rate at the time of sanction or renewal.
c. Changes in the Base Rate shall be applicable in respect of all existing loans
linked to the Base Rate, in a transparent and non-discriminatory manner.
d. Since the Base Rate will be the minimum rate for all loans, banks are not
permitted to resort to any lending below the Base Rate. Accordingly, the
current stipulation of BPLR as the ceiling rate for loans up to Rs. 2 lakh
stands withdrawn. It is expected that the above deregulation of lending rate
will increase the credit flow to small borrowers at reasonable rate and direct
bank finance will provide effective competition to other forms of high cost
credit.
e. Banks are required to review the Base Rate at least once in a quarter with the
approval of the Board or the Asset Liability Management Committees
(ALCOs) as per the banks practice. Since transparency in the pricing of
K.E.S College of Arts & Commerce
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Base Rate
lending products has been a key objective, banks are required to exhibit the
information on their Base Rate at all branches and also on their websites.
Changes in the Base Rate should also be conveyed to the general public
from time to time through appropriate channels. Banks are required to
provide information on the actual minimum and maximum lending rates to
the Reserve Bank on a quarterly basis, as hitherto.
f. The Base Rate system would be applicable for all new loans and for those
old loans that come up for renewal. Existing loans based on the BPLR
system may run till their maturity. In case existing borrowers want to switch
to the new system, before expiry of the existing contracts, an option may be
given to them, on mutually agreed terms. Banks, however, should not charge
any fee for such switch-over.
g. Interest rates under the BPLR system are applicable to all existing loans
sanctioned up to June 30, 2010. However, wherever loans sanctioned up to
June 30, 2010 come up for renewal from July 1, 2010, the Base Rate system
would be applicable. The guidelines on Benchmark Prime Lending Rate
(BPLR) and Spreads and its determination for existing loans sanctioned up
to June 30, 2010 are given in Annex 3 and Annex 4.
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2.4
Base Rate
Impact:
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the BPLRs of banks have turned out to be the maximum lending rates in
most cases, distorting the information content.
F. Big borrowers:
As per the earlier system big and high creditworthy borrowers were the
kings. Chased by banks, they bargained hard to extract maximum possible
discount on BPLR. Now also they will continue to get money close to the
base rate. To collect funds below the base rate, corporates will also float of
K.E.S College of Arts & Commerce
24
Base Rate
commercial papers for short term money and debentures for medium term
borrowings with low interest rates. Since buying such instruments will be
treated as investments, they will not come under the base rate stipulation.
Banks, however, will have limited exposures in such securities because their
prices will vary in the market requiring provisions for loss of value under
mark to market accounting norms.
G. Small borrowers:
Companies with lower credit ratings and small & medium businesses may
get marginal benefit under the new system. All these days they were fleeced
by banks by way of higher interest rates in the garb of high credit risk.
Under the new system banks will charge risk premium to the relatively
weaker borrowers, however, if the interest rate is too high from the base rate
they will find it hard to justify. Transparency in base rate calculation may
arm weaker borrowers to question unrealistic high rates.
2.5
Impact on Home loan Customers:But not all home loan customers would benefit linking their loans to the new
benchmarking system. For example, if you have taken a teaser loan just few
months back, it would still make sense to stick to it.
And with SBI planning to continue its teaser rate of 8 per cent for the next
three months, borrowers would continue to benefit.
In dual rate (or teaser) loans, a borrower gets fixed rates for the initial
years. This means, there is predictability of monthly outgo for this period
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Base Rate
and the borrower, in turn can plan his finance accordingly without bothering
about interest rate fluctuation, said a certified financial planner.
For an existing borrower, there are some situations in which they will benefit
by shifting. In other cases, it may not make much difference.
A. Less than one year: If you have taken the loan just a year back, around 90
per cent of the equated monthly installment (EMI) goes towards repayment
of interest and the rest towards principle.
If serving a floating rate loan for less than two years, financial planner said it
makes sense to shift the loan even if the lender is charging you an interest
of 9-9.5 per cent.
When a person shifts to base rate, the interest is likely to remain the same. In
addition, shifting is free. Shifting early to the new benchmark would only
help to get the benefits earlier. And if the existing loan rate is around 1-2 per
cent lower than your existing rate, it makes sense to renegotiate as well.
Of course, there will be a charge. But you can easily get into a new regime
which is completely new and more sensitive to changes.
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Base Rate
There are customers who fixed their loan rate at 7.5-8 per cent in 2003-04
periods; it makes less sense for them to shift. Especially, if their loan rate is
fixed for the entire tenure.
D. Over 10 years: If your loan tenure is of 20 years, almost 50 per cent of the
time period is remaining. But the good part is that most of the interest payout
has taken place.
1. During these years, the principle portion in the EMI accounts for 60 per cent
or more, as you get closer to repaying the loan. Shifting to base rate is a
tough call in such a situation.
2. Do your math and compare the advantages of BPLR vis-a-vis base rate. If
you have more than three years to repay the loan and you still saving money
on the EMI, go for it.
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Base Rate
3. Shift to base rate anyway. Because it will ensure that you get the advantage
of loan rate fluctuations.
5. If the blue-chips stand to lose in the new regime, who stands to gain? Some
would argue that banks subsidized the low-cost loans to their prime
borrowers by charging hefty rates from smaller, riskier borrowers small
and medium enterprises and households, for example.
6. Those who argue this claim that once banks are forced to price loans in line
with their costs, these subsidies are likely to disappear and the segments
that arguably need the money the most are likely to get fairer rates.
7. The other thing that the base rate could prevent to a degree is what
regulators term predation the phenomenon of large banks dropping loan
rates way below costs to grab market share.
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Base Rate
10. It would at least provide a better gauge of whether monetary policy changes
are making a difference to borrowing and lending rates on the ground. There
is a case to be made for some structural changes in the policy rates as well.
11. As the current liquidity crunch in the banking system has shown, the wide
gap of one-and-half percentage points between the reverse repo and the repo
rates drives a large swing in short-term interest rates as the banking system
goes from surplus to deficit and vice versa.
12. This volatility is perhaps undesirable and can be ironed out by reducing this
gap. A hike in the reverse repo rate, keeping the repo rate unchanged in the
RBIs July 27 Monetary Policy could do the trick.
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2.6
Base Rate
Base Rate=+++
a - Cost of Deposits=
b - Negative Carry on CRR and SLR= 1 + 100
Where:
Cost of Deposits
Total Deposits= Time Deposits + Current Deposits + Saving Deposits
Deployable Deposits
=Total deposits less share of deposits locked as CRR and SLR balances,.
= 1 +
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NP : Net Profit
TL : Total Liabilities
Negative carry on CRR and SLR balances arises because the return on CRR
balances is nil, while the return on SLR balances (proxied using the 364-day
Treasury Bill rate) is lower than the cost of deposits. Negative carry on CRR
and SLR is arrived at in three steps. In the first step, return on SLR
investment was calculated using 364-day Treasury Bills. In the second step,
effective cost was calculated by taking the ratio (expressed as a percentage)
of cost of deposits (adjusted for return on SLR investment) and deployable
deposits (total deposits less the deposits locked as CRR and SLR balances).
In the third step, negative carry cost on SLR and CRR was arrived at by
taking the difference between the effective cost and the cost of deposits.
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Average Return on Net Worth is computed as the product of net profit to net
worth ratio and net worth to total liabilities ratio expressed as a percentage.
a. Since no bank will be permitted to give loans below the base rate, large
companies, which had been getting loans lower than the benchmark prime
lending rate, will now have to pay as much as 200 basis points more as per
the Bankers. The most important thing to keep in mind is that the cost of
money is not changing, i.e., if my car loan cost about 12% or home loan cost
9%, this rate of interest charged to me will be no different going forward.
Its just that the method used to arrive at this will be clearer. So, interest
rates arent coming down as a result of this base rate implementation.
b. Following on from this, EMI on an existing loan is also not going to change.
We will continue to pay whatever we were paying up to last month in future
months as well. The most common question that has been arising in the
minds of the people is that should they shift to the Bank with the lower base
rate? But shifting to the Bank with lower base rate will not be able to do
major difference.
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Base Rate
c. Banks will now be more precise in selecting the premium for risk and
tenure, resulting in an increase in the loan rates to the corporate sector, Cost
of borrowing will slightly increase, and to the extent money is borrowed
from the banks. Once a base rate is determined, bank will not be able to give
a loan to any corporate below the base rate. At this moment, there are some
AAA companies who are enjoying a 77.5 per cent rate according to the
bankers.
d. At least six other public sector banks, including Punjab National Bank and
Bank of Baroda, announced their base rateall pegging it at 8%. Private
Banks, including ICICI Bank Ltd, Indias second largest lender. For every
bank, the base rate is lower than the BPLR which it replaces, but that does
not necessarily mean that the cost of money will decline for borrowers. This
is because no bank will be allowed to price loans cheaper than the base rate.
The new regime has been put in place by the Reserve Bank of India to
ensure that small businesses dont end up subsidizing below-BPLR
borrowings by top-rated firms that have been able to raise funds at much
lower rates.
e. Until now, around 70% of borrowers have been raising money at below
BPLR. Although the BPLR of most public sector banks ranges between
11.5% and 12.5%, triple A-rated corporate borrowers were raising shortterm loans at a rate as low as 6.75-7%. Private Banks are expected to set
their base rate lower, but their public sector counterparts are not worried
about losing customers to the competition.
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2.7
Base Rate
Banks
website
for
public
comments.
Based
on
the
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Base Rate
i. The Base Rate system will replace the BPLR system with effect from July
1, 2010. Base Rate shall include all those elements of the lending rates that
are common across all categories of borrowers. Banks may choose any
benchmark to arrive at the Base Rate for a specific tenor that may be
disclosed transparently. Banks are free to use any other methodology, as
considered appropriate, provided it is consistent and are made available for
supervisory review/scrutiny, as and when required.
ii. Banks may determine their actual lending rates on loans and advances
with reference to the Base Rate and by including such other customer
specific charges as considered appropriate.
iii. In order to give banks some time to stabilize the system of Base Rate
calculation, banks are permitted to change the benchmark and methodology
any time during the initial six month period i.e. end-December 2010.
iv. The actual lending rates charged may be transparent and consistent and
be made available for supervisory review/scrutiny, as and when required.
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Base Rate
vi. The Base Rate could also serve as the reference benchmark rate for
floating rate loan products, apart from external market benchmark rates. The
floating interest rate based on external benchmarks should, however, be
equal to or above the Base Rate at the time of sanction or renewal.
vii. Changes in the Base Rate shall be applicable in respect of all existing
loans linked to the Base Rate, in a transparent and non-discriminatory
manner.
viii. Since the Base Rate will be the minimum rate for all loans, banks are
not permitted to resort to any lending below the Base Rate. Accordingly, the
current stipulation of BPLR as the ceiling rate for loans up to Rs. 2 lakh
stands withdrawn. It is expected that the above deregulation of lending rate
will increase the credit flow to small borrowers at reasonable rate and direct
bank finance will provide effective competition to other forms of high cost
credit.
ix. Reserve Bank of India will separately announce the stipulation for
export credit.
x. Banks are required to review the Base Rate at least once in a quarter with
the approval of the Board or the Asset Liability Management Committees
(ALCOs) as per the banks practice. Since transparency in the pricing of
lending products has been a key objective, banks are required to exhibit the
information on their Base Rate at all branches and also on their websites.
Changes in the Base Rate should also be conveyed to the general public
K.E.S College of Arts & Commerce
36
Base Rate
xi. The Base Rate system would be applicable for all new loans and for those
old loans that come up for renewal. Existing loans based on the BPLR
system may run till their maturity. In case existing borrowers want to switch
to the new system, before expiry of the existing contracts, an option may be
given to them, on mutually agreed terms. Banks, however, should not charge
any fee for such switch-over.
xii. In line with the above Guidelines, banks may announce their Base Rates
after seeking approval from their respective ALCOs/ Boards.
xiii. The above guidelines on the Base Rate system will become effective on
July 1, 2010.
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Base Rate
CHAPTER 3
CASH RESERVE RATIO & STATUTORY RESERVE
RATIO
__________________________________________________
3.1 CASH RESERVE RATIO
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Base Rate
CHAPTER 3
CASH RESERVE RATIO & STATUTORY RESERVE
RATIO
3.1
A. Maintenance of CRR
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Base Rate
amount of which shall not be less than three per cent of the total of the Net
Demand and Time Liabilities (NDTL) in India, on a fortnightly basis and
RBI is empowered to increase the said rate of CRR to such higher rate not
exceeding twenty percent of the Net Demand and Time Liabilities (NDTL)
under the RBI Act, 1934. At present, effective from the fortnight beginning
June 14, 2003, the rate of CRR is 4.50 per cent of the NDTL.
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Base Rate
D. Demand Liabilities
'Demand Liabilities' include all liabilities which are payable on demand and
they include current deposits, demand liabilities portion of savings bank
deposits, margins held against letters of credit/guarantees, balances in
overdue fixed deposits, cash certificates and cumulative/recurring deposits,
outstanding Telegraphic Transfers (TTs), Mail Transfer (MTs), Demand
Drafts (DDs), unclaimed deposits, credit balances in the Cash Credit account
and deposits held as security for advances which are payable on demand.
Money at Call and Short Notice from outside the Banking System should be
shown against liability to others.
E. Time Liabilities
Time Liabilities are those which are payable otherwise than on demand and
they include fixed deposits, cash certificates, cumulative and recurring
deposits, time liabilities portion of savings bank deposits, staff security
deposits, margin held against letters of credit if not payable on demand,
deposits held as securities for advances which are not payable on demand,
India Millennium Deposits and Gold Deposits.
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Base Rate
When a bank accepts funds from a client under its remittance facilities
scheme, it becomes a liability (liability to others) in its books. The liability
of the bank accepting funds will extinguish only when the correspondent
bank honours the drafts issued by the accepting bank to its customers. As
such, the balance amount in respect of the drafts issued by the accepting
bank on its correspondent bank under the remittance facilities scheme and
remaining unpaid should be reflected in the accepting bank's books as an
outside liability and the same should also be taken into account for
computation of NDTL for CRR/SLR purpose. The amount received by
correspondent banks has to be shown as 'Liability to the Banking System' by
them and not as 'Liability to others' and this liability could be netted off by
the correspondent banks against the inter-bank assets. Likewise sums placed
by banks issuing drafts/interest/dividend warrants are to be treated as 'Assets
with Banking System' in their books and can be netted off from their interbank liabilities.
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Base Rate
43
Base Rate
maintain the prescribed Cash Reserve Ratio (@ 4.50 per cent with effect
from the fortnight beginning June 14, 2003).
K. Penalties
44
3.2
Base Rate
45
Base Rate
The procedure to compute total net demand and time liabilities for the
purpose of SLR under Section 24 (2) (B) of B.R. Act 1949 is similar to the
procedure followed for CRR purpose. However, it is clarified that Scheduled
Commercial Banks are required to include inter-bank term deposits / term
borrowing liabilities of original maturities of 15 days and above and up to
one year in Liabilities to the Banking System'. Similarly banks should
include their inter-bank assets of term deposits and term lending of original
maturity of 15 days and above and up to one year in 'Assets with the
Banking System' for the purpose of maintenance of SLR. However, both the
above liabilities and assets are not to be included in liabilities/assets to the
banking system for computation of DTL/NDTL for the purpose of CRR as
mentioned in paragraph 2.3.7 above.
The entire investment portfolio of the banks (including SLR Securities) will
be classified under three categories viz.' Held to Maturity', 'Available for
sale' and 'Held for Trading'. Investment classified under Held to Maturity
category need not be marked to market and will be carried at acquisition cost
unless it is more than the face value. In such a case, the premium should be
amortized over a period remaining to maturity. Individual scrips in the
K.E.S College of Arts & Commerce
46
Base Rate
C. Penalties
3.3
REPO RATE
Repo rate is the rate at which our banks borrow rupees from RBI. This
facility is for short term measure and to fill gaps between demand and
supply of money in a bank .when a bank is short of funds they borrow from
RBI at repo rate .A reduction in the repo rate will help banks to get money at
47
Base Rate
a cheaper rate. When the repo rate increases borrowing from RBI becomes
more expensive. To borrow from RBI bank have to submit liquid bonds
/Govt Bonds as collateral security ,so this facility is a short term gap filling
facility and bank does not use this facility to Lend more to their customers.
3.4
REVERSE REPO
Reverse Repo rate is the rate which is paid by RBI to banks on Deposit of
funds with RBI. ( present rate is 3.75 as on 02.07.2010)and if bank has a
surplus fund then they deposit the funds with RBI and earn interest at
Reverse repo rate.
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3.5
Base Rate
BANK RATE
Bank rate is the minimum rate at which the central bank provides loans to
the commercial banks. It is also called the discount rate. Usually, an increase
in bank rate results in commercial banks increasing their lending rates.
Changes in bank rate affect credit creation by banks through altering the cost
of credit. The bank rate signals the central bank's long-term outlook on
interest rates. If the bank rate moves up, long-term interest rates also tend to
move up, and vice-versa. Banks make a profit by borrowing at a lower rate
and lending the same funds at a higher rate of interest. If the RBI hikes the
bank rate, the interest that a bank pays for borrowing money (banks borrow
money either from each other or from the RBI) increases. It, in turn, hikes its
own lending rates to ensure it continues to make a profit. Currently the bank
rate is 6% (As on August 2010).
49
Base Rate
CHAPTER 4
BENCHMARK PRIME LENDING RATE (BPLR)
____________________________________________________
4.1 INTRODUCTION
4.2 BENCHMARK PRIME LENDING RATE (BPLR) AND SPREADS
4.3 DETERMINATION OF BENCHMARK PRIME LENDING RATE
(BPLR)
4.4 FREEDOM TO FIX LENDING RATES
50
Base Rate
CHAPTER 4
BENCHMARK PRIME LENDING RATE (BPLR)
4.1
INTRODUCTION
51
Base Rate
d. An objective of financial sector reform has been to ensure that the financial
repression inherent in administered interest rates is removed. Accordingly,
in the context of granting greater functional autonomy to banks, effective
October 18, 1994, it was decided to free the lending rates of scheduled
commercial banks for credit limits of over Rs. 2 lakh; for loans up to Rs. 2
lakh, it was decided that it was necessary to continue to protect these
borrowers by prescribing the lending rates. For credit limits of over Rs.2
lakh, the prescription of minimum lending rate was abolished and banks
were given the freedom to fix the lending rates for such credit limits. Banks
are now required to obtain the approval of their respective Boards for the
Benchmark Prime Lending Rate (BPLR), which would be the reference
rate for credit limits of over Rs.2 lakh. Each bank's BPLR has to be
declared and be made uniformly applicable at all branches.
4.2
BENCHMARK
SPREADS
a. With effect from October 18, 1994, RBI has deregulated the interest rates
on advances above Rs.2 lakh and the rates of interest on such advances are
determined by the banks themselves subject to BPLR and Spread guidelines.
For credit limits up to Rs.2 lakh, banks should charge interest not exceeding
their BPLR. Keeping in view the international practice and to provide
K.E.S College of Arts & Commerce
52
Base Rate
b. Given the prevailing credit market in India and the need to continue with
concessionality for small borrowers, the practice of treating BPLR as the
ceiling for loans up to Rs. 2 lakh will continue.
c. Banks are free to determine the rates of interest without reference to BPLR
and regardless of the size in respect of loans for purchase of consumer
durables, loans to individuals against shares and debentures / bonds, other
non-priority sector personal loans, etc. BPLR will be made uniformly
applicable at all branches of a bank.
4.3
53
Base Rate
4.4
ii.
iii.
iv.
54
Base Rate
vi.
Discounting of Bills;
vii.
x.
55
Base Rate
CHAPTER 5
BASE RATE V/S. BPLR RATE
____________________________________________________
5.1 BASE RATE OF BPLR RATE WHICH IS BETTER
5.2 WORKING GROUP ON BPLR
5.3 WHAT ARE THE MAIN RECOMMENDATIONS OF THE BPLR
GROUP?
56
Base Rate
CHAPTER 5
BASE RATE V/S. BPLR RATE
5.1
B. Questions about the BPLR system being out of sync with market conditions
have been arising since quite some time. Customers were dissatisfied with
this system of lending as they felt banks lent money to strong and rich
corporate at sub BPLR rate. Lending operations in a bank act as a major aid
in the growth of the economy of a nation. It is through reasonable and just
lending rates that banks can direct fund flow in the economy for productive
purposes. Also the variation in BPLR was so wide amongst banks that it
stretched to over 4% sometimes.
C. Thus in order to come over all these delinquencies, the RBI appointed a
working group headed by Shri Deepak Mohanty to study the ongoing
activities pertaining to BPLR and hence present a report. The report was
57
Base Rate
D. Thus the RBI, in a drive to initiate the replacement of the BPLR system of
lending came up with the base rate system. The base rate would include all
cost elements which can be clearly defined and are common to all
borrowers. The base rate is directed to come into effect from 1st April 2010.
The banks have been given the liberty to choose their own base rate.
E. The base rate would be calculated by banks based on four major factors:
a. cost of deposits
b. cost of adjustment for negative carry in respect of CRR and SLR
c. unallocatable overhead costs
d. profit margin
F. The actual rate charged to borrowers would be base rate plus borrower
specific charges depending on the credit risk premium and creditworthiness
of the borrower.
G. With the base rate system coming into play, the banks will no longer be
lending below the base rate as used to be the case with BPLR. This step is in
58
Base Rate
line with RBI's expectation that with deregulation in lending rates there will
be an increase in the credit flow to small borrowers.
H. Since lack of transparency in deciding the lending rates was one of the major
factors which led RBI to opt in for a new benchmark, so banks are needed to
exhibit information on their base rate to all their branches and also on their
website. Changes in the base rate will also have to be conveyed to the
general public using appropriate channels.
I. The base rate system will be applicable to all fresh loan applications and also
for old loans that have been demanded for renewal. If an existing borrower
wants to change to the new lending system then it can be done by the mutual
consent of both the customer and the respective bank.
J. Initially the base rate system was welcome by many criticisms arising from
the banks. Since this system allowed every bank to price its loan individually
so each bank would price its loan according to the cost of funds and
operating efficiencies. This implies that a bank with a higher CASA ratio
will benefit more than the one with a lower ratio.
K. CASA stands for current and savings account. The CASA ratio shows out of
the total deposits available with a bank, how much is attributable to current
and savings deposits.
59
Base Rate
M. This infers that banks with high CASA ratios will benefit themselves and
banks with base rates at the higher end are sure to have a tuff time
competing in this highly competitive business. But in this race the customer
seems to be in a win-win scenario. As the banks fight for the best lending
rate, the customer gets to have the cherry of the cake.
N. Base rate as the name suggest, will be the base interest rate applicable to the
borrowers. It does not change the interest outgo on your existing or new
loans however it's pegged against a new base for all future calculations.
Borrowers continue to pay same interest rate and some banks might provide
an option of switching to base rate for its customers (even though the actual
money does not change). Even though banks are restricted from lending
below the Base rate, in certain situations they can do so, but only for short
term loans.
60
5.2
Base Rate
While initiating the move to replace the existing system of BPLR, RBI felt
that the existing lending rate system had lost relevance and hindered
effective transmission of monetary policy signals. For example, RBI
reduced its benchmark lending rate by 425 basis points in the last one year,
but banks reduced their BPLR by about 200 basis point cut. This was
mainly because bulk of their lending was below their BPLR. Although,
prime rates (read BPLR) of Indian banks ranged between 11 percent and
15.75 percent, yet three-fourths of their total loans are made below these
levels because of competitive pressures in the fragmented banking sector.
The panel said while market conditions may necessitate lending below the
base rate, the need may be only for a short term. Besides, to ensure that such
lending does not proliferate, it should not exceed 15 percent.
61
Base Rate
(i)
(ii)
(iii)
(iv)
(v)
(vi)
5.3
The proposed Base Rate will include all those cost elements which can be
clearly identified and are common across borrowers. The constituents of the
Base Rate would include (i) the card interest rate on retail deposit (deposits
below Rs. 15 lakh) with one year maturity (adjusted for CASA deposits);
62
Base Rate
(ii) adjustment for the negative carry in respect of CRR and SLR; (iii)
unallocatable overhead cost for banks which would comprise a minimum set
of overhead cost elements; and (iv) average return on net worth.
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.
With the proposed system of Base Rate, there will not be a need for banks to
lend below the Base Rate as the Base Rate represents the bare minimum rate
below which it will not be viable for the banks to lend. The Group, however,
also recognizes certain situations when lending below the Base Rate may be
necessitated by market conditions. This may occur when there is a large
surplus liquidity in the system and banks instead of deploying funds in the
LAF window of the Reserve Bank may prefer to lend at rates lower than
their respective Base Rates. The Group is of the view that the need for such
lending may arise as an exception only for very short-term periods.
Accordingly, the Base Rate system recommended by the Group will be
applicable for loans with maturity of one year and above (including all
working capital loans).
63
Base Rate
Banks may give loans below one year at fixed or floating rates without
reference to the Base Rate. However, in order to ensure that sub-Base Rate
lending does not proliferate, the Group recommends that such sub-Base Rate
lending in both the priority and non-priority sectors in any financial year
should not exceed 15 per cent of the incremental lending during the financial
year. Of this, non-priority sector sub-Base Rate lending should not exceed 5
per cent. That is, the overall sub-Base Rate lending during a financial year
should not exceed 15 per cent of their incremental lending, and banks will be
free to extend entire sub-Base Rate lending of up to 15 per cent to the
priority sector.
The Base Rate could also serve as the reference benchmark rate for floating
rate loan products, apart from the other external market benchmark rates.
64
Base Rate
The interest rate on rupee export credit should not exceed the Base Rate of
individual banks. As export credit is of short-term in nature and exporters
are generally wholesale borrowers, there is need to incentivize export credit
for exporters to be globally competitive. By this change in stipulation of
pricing of export credit, exporters can still access rupee export credit at
lower rates as the Base Rate envisaged is expected to be significantly lower
than the BPLRs. The Base Rate based on the methodology suggested by the
Group is comparable with the present lending rate of 9.5 per cent charged by
the banks to most exporters. The proposed system will also be more flexible
and competitive.
At present the interest rates on education loans are linked to ceilings with
reference to the BPLR. In view of the critical role played by education loans
in developing human resource skills, the interest rate on these loans may
continue be administered. However, in view of the fact that the Base Rate is
expected to be significantly lower than BPLR; the Group recommends that
there is a need to change the mark up. Accordingly, the Group recommends
that the interest rates on all education loans may not exceed.
65
Base Rate
CHAPTER 6
DATA ANALYSIS AND INTERPRETATION
66
Base Rate
CHAPTER 6
DATA ANALYSIS AND INTERPRETATION
Different Base Rate of Banks and their fixed load
Load
Base Rate
Bank
HDFC HSBC
of
Bank Bank
Baroda
Allaha
bad
Bank
Axis
Bank
1.75
1.25
0.75
1.5
1.25
0.75
1.25
0.5
1.5
7.5
7.25
7.5
7.25
7.5
ICICI
Bank
In fixing base their these two things to be followed one is the fixed and other is
fixed load the base rate is variable but fixed load remains fixed for longer period of
time. The base can be changed but fixed load remains the same. In the above
diagram it shows base rate its fixed loads of different banks. We have taken data
from 10 banks to see how each bank loads its home loan. Remember that all other
loans will be prices in a similar fashion.
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Base Rate
While most base rate announced till now are in a range of 7.2% - 8%, the
load for each bank varies from as low as 0.5% to as high as 6%.
For example, the base rate of IDBI Bank ltd is 8%. With a load of 0.75% for
loans between Rs.20 lakh and Rs.30 lakh over 15 years, the final interest rates
comes to 8.75% (base rate plus load). Similarly, for loans between Rs.30 lakh and
Rs.50 lakh for the same period, the load is 1% and, thus the final interest rate goes
up to 9%. Kotak Mahindra Bank Ltd, on the other hand, has a lower base rate of
7.25% and a higher load 1.25% for loans for salaried customers, irrespective of the
amount and tenor.
Load
Base Rate
Bank
HDFC HSBC
of
Bank Bank
Baroda
State Union
Kotak
IDBI
Bank Bank
Mahin
of
of
Bank
dra
India India
Allaha
bad
Bank
Axis
Bank
1.75
1.75
1.5
1.5
1.5
1.25
0.5
7.5
7.25
7.5
7.25
7.5
68
ICICi
Bank
Base Rate
69
Base Rate
Most of the public sector banks have fixed their base between 8% and some fixed
to 7.50% - 7.75%
Base Rate
8.40%
8.20%
8.00%
7.80%
7.60%
Base Rate
7.40%
7.20%
7.00%
Bank
HDFC Bank
7.25%
ICICI Bank
7.50%
Dhanlaxmi Bank
7.75%
Bank of Rajasthan
8.00%
8.50%
HSBC Bank
7.00%
70
Base Rate
Base Rate
9.00%
8.00%
7.00%
6.00%
5.00%
4.00%
3.00%
2.00%
1.00%
0.00%
Base Rate
HDFC
Bank
ICICI
Bank
Dhanlax
mi Bank
Bank of
Rajasthan
7.25%
7.50%
7.75%
8.00%
71
Karur
Vysya
Bank
8.50%
HSBC
Bank
7.00%
Base Rate
Appendix -I
CIRCULAR FROM RBI
Draft Circular
RBI/2009-10/
Ref.No.MPD.BC.
February , 2010
/10.14.01/2009-10
Magha , 1931(S)
To,
All Scheduled Commercial Banks
1. Following the announcement in the Annual Policy Statement for the year
2009-10, the Reserve Bank constituted a Working Group on Benchmark Prime
Lending Rate (Chairman: Shri Deepak Mohanty) to review the present
benchmark prime lending rate (BPLR) system and suggest changes to make
credit pricing more transparent. The Working Group submitted its report on
October 20, 2009 and it was placed on the Reserve Banks website for public
comments. After considering the recommendations of the Group and the
suggestions from various stakeholders, the Reserve Bank has decided as
follows:
2. The Base Rate system will replace the BPLR system with effect from April
1, 2010. Banks may determine their actual lending rates on loans and advances
with reference to the Base Rate. Base Rate shall include all those elements of
72
Base Rate
the lending rates that are common across all categories of borrowers. While
each bank may decide its own Base Rate, some of the criteria that could go into
the determination of the Base Rate are: (i) cost of deposits; (ii) adjustment for
the negative carry in respect of CRR and SLR; (iii) unallocatable overhead cost
for banks such as aggregate employee compensation relating to administrative
functions in corporate office, directors and auditors fees, legal and premises
expenses, depreciation, cost of printing and stationery, expenses incurred on
communication and advertising, IT spending, and cost incurred towards deposit
insurance; and (iv) profit margin. An illustration for computing the Base Rate is
set out in the Annex.
3. 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.
4. All categories of loans should henceforth be priced only with reference to the
Base Rate. The Base Rate could also serve as the reference benchmark rate for
floating rate loan products, apart from the other external market benchmark
rates. The floating interest rate based on external benchmarks should, however,
be equal to or above the Base Rate at the time of sanction or renewal.
5. Since the Base Rate will be the minimum rate for all commercial loans,
banks are not permitted to resort to any lending below the Base Rate.
Accordingly, the current stipulation of BPLR as the ceiling rate for loans up to
Rs. 2 lakh stands withdrawn. It is expected that deregulation of lending rates
will increase the credit flow to small borrowers at reasonable rate. Thus, direct
73
Base Rate
bank finance will provide effective competition to other forms of high cost
credit.
6. Interest rates on loans under the DRI scheme will continue to be fixed
without reference to the Base Rate.
7. The Reserve Bank will separately announce the stipulation for export credit.
9. 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 new/revised rate structure should be mutually agreed upon by the
bank and the borrower.
74
Base Rate
10. In line with the above Guidelines, banks may announce their Base Rates
after seeking approval from their respective Boards.
(Janak Raj)
Adviser-in-Charge
Encl: As above.
75
Base Rate
Annexure 2
76
Base Rate
77
Base Rate
Annexure- 3
78
Base Rate
79
Base Rate
80
Base Rate
81
Base Rate
82
Base Rate
83