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Responding to the widespread feeling that banks do not set their lending rates in a scientific and transparent manner, the Reserve Bank of India is in the last stages of the consultative process to introduce a new system. The proposed system will replace the existing system of benchmark prime lending rates (BPLR) with base rates. The formula for calculating the base rate will take into account the cost of deposits, cost of complying with CRR and SLR requirements, and the need to retain a profit margin. Plus there will be a markup depending on the cost of operation for a particular type of product and premiums for credit risk and tenor of loans. The proposed method is clearly more scientific than the present system for calculating BPLRs. Additionally, sub-BPLR lending for loans below Rs 2 lakh will be stopped. This need not raise rates for small loans as the new base rates are likely to be lower than BPLRs. More important, it is argued that as non-bank credit is invariably costlier, making small loans affordable for banks will raise the supply of such credit and thus be beneficial on the balance to small borrowers. To set floating rate loans, the new base rates as also external benchmarks can be used, though the rate should not fall below the base rate. There will be no change in the regime for Differential Rate Interest loans (there isn’t much of such lending) and regulation of export credit will be handled separately.

To see if the new system will be better than the existing one, it is necessary to list what is currently going wrong. The BPLR system does not quickly or adequately respond to changes in policy rates, thus reducing the effectiveness of monetary policy. There is a lack of transparency in rate fixing, resulting in the allegation that small borrowers and farmers are subsidising corporates. BPLRs, in any case, have become somewhat meaningless as the bulk of loans are currently being given at sub-BPLR rates. But it is difficult to see the proposed system creating greater responsiveness to changes in policy rates as both the present and the new systems will be linked to the cost of funds (deposit rates) which tends to respond more quickly to policy rate and liquidity changes. Transparency will certainly be enhanced by the more elaborate process of calculating the base rate according to a given formula and the need to adequately publicise the rate.

But the feeling among individuals borrowing under flexible rates that they face an opaque system which is changed or not solely according to the needs of banks, is unlikely to go away. Things would have really helped if it were mandated that all floating rate loans should be clearly linked to the base rate (e.g., 2 percentage point more) and, more important, the rate automatically and mandatorily changed in response to base rate changes. Currently individual borrowers have to keep pointing to publicly announced lowering of bank BPLR and asking for a similar revision for themselves. Unless this happens, existing borrowers are likely to see themselves paying higher rates of interest than new borrowers (rates tend to float up over time), irrespective of whether teaser rates are formally discontinued or not. As for large corporate borrowers negotiating very fine rates for themselves, that is likely to continue as banks will have to oblige them under competitive pressure.

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June 2024