Floating-rate home loan borrowers, who often felt they got a raw deal, will now have a reason to cheer. The Reserve Bank of India’s (RBI) new rules will ensure that they get the full benefit of any reduction in interest rates. In its final guidelines on the base rate — the new benchmark that banks will use to price loans — the regulator has made it clear that any change in the base rate will apply to new as well as old customers. Banks often offered lower rates and even teaser-rate schemes to attract new customers.
However, existing customers were left out of these schemes, even though they had taken loans at floating rates. As a result, floating-rate borrowers did not get the full benefit of falling rates. This is expected to change, with the new guidelines on base rate coming into effect from July 1.
The central bank has said: “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.” It also said, “the actual lending rates charged may be transparent and consistent”.
The regulator had said that the base rate system was aimed at enhancing transparency in lending rates and would lead to a better assessment of monetary policy transmission. According to the RBI formula, the base rate factors in only cost and profit margin while risk and tenure premia will be charged over and above the base rate. However, RBI has given banks the freedom to use any other methodology, provided it is consistent and is made available for supervisory review or scrutiny when required.
The base rate will be the minimum interest rate, and banks will not be able to lend below it. The RBI has, however, made exceptions in cases of loans to employees, loans against deposits and differential rates of interest schemes. In such cases, the rates can be below the base rate. The central bank will separately announce export credit norms. Even a loan below Rs 2 lakh, on which RBI had so far stipulated that the benchmark prime lending rate, or BPLR, would be maximum rate that a bank could charge, will not be below the base rate.
“Now that banks can’t lend below the base rate, the commercial paper and non-convertible debenture market will grow. Second, our concern on short-term loans is addressed, given that the RBI has given banks freedom to have their own formula on base rate,” said JP Dua, CMD of Allahabad Bank.
Base rate will replace BPLR. Banks will be allowed to use the BPLR system till December 2010. However, during the six months (till December 2010), banks have been allowed to change the benchmark and the methodology till the system stabilises. Thereafter, they are required to review their base rates at least once in three months.
The central bank has also allowed banks to choose any benchmark to arrive at the base rate for a specific tenure that may be disclosed transparently. Base rate could, thus, vary from one bank to another. Some banks may take 14-day deposits as their cost while others could price it based on their costs for a 1-year deposit. Base rate should also include all lending rate elements that are common across all categories of borrowers.
All new loans should be linked to the base rate and existing loans should be moved towards it when they come up for renewal. Banks will not be allowed to charge any fee if a customer wishes to switch to the base rate before the existing contract expires.