Shift from BPLR to Base Rate

Recently with release of RBI circular on Base rate implementation, there has been a lot of debate going on regarding BPLR (benchmark prime lending rate). Here is our beginner’s guide to understand the two rates.

What is BPLR?

BPLR is the reference rate for banks for pricing their loan products. It is calculated taking into account the cost of funds, operational expenses, and the minimum margin to cover regulatory requirements of provisioning and capital and profit margin. Banks are supposed to lend to their prime customers at BPLR and increase the rate with risk premium in case of sub-prime customers and tenor premium wherever applicable.

Problems with BPLR

1. Main problem with BPLR is that banks have resorted to sub-BPLR lending. On an average, 67% of the total loans and Advances of banks was sub-BPLR. For Private banks, the figure was even higher at 83%. Housing, agriculture, and corporate segments were the major beneficiaries of sub-BPLR lending. Nearly 31% of the housing loans in FY08 were disbursed at an interest rate of less than 10%, while 49% of the housing loans were disbursed at 10-12%. In the case of loans to the industry, around 32% were disbursed at an interest rate of 10-12%.

A study of BPLR and actual lending rates of the banks show that as on Sep’2009, against a BPLR in the range of 11-13.5% for public sector banks, actual lending rates where in the range of 4.2-18%. For private banks, actual lending rates were 3-29.5% against BPLR of 12.5-16.7%.

2. Secondly, BPLR failed to respond to the changes in the monetary policy. Changes in monetary policy rates by RBI were not truly reflected in the BPLR. This was true during both the tightening phase as well as easing phase. This defeated the purpose of changes in these rates to some extent. Table below illustrates the point where changes in policy rates have not resulted in a proportionate change in the BPLR of the banks.

What is base rate?

Base rate would be the new benchmark of pricing of loan products by the banks. It 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. As per the calculation of RBI, using the date of financial year 2008-09, the base rate for Indian banks works out to be about 8.55%. Banks would not be allowed to lend below the base rate except for Loans against fixed deposits, loans given by a bank to its own employees, as well as restructured loans, where borrowers get more time and pay lower rates to avert defaults.

Expected impact of Base rate

It is expected that base rate system will increase transparency in credit pricing and address the shortcomings of the BPLR system. Benchmark rate of most of the banks will decline to single digit. Again with the base rate, including negative carry on Cash Reserve Ratio (CRR) and Statutory Liquidity ratio (SLR) it is anticipated that base rate will be directly impacted by the monetary measures initiated by the RBI. Taking the calculation of RBI, Ceteris paribus, with an increase of 75 bps in the CRR, the base rate increases by 8 bps to 8.63% and an increase of 100 bps in the SLR from 24% to 25% could push up the minimum lending rate by 12 bps to 8.67%.

Small borrowers such as farmers who are close to BPLR rates would get credit at reasonable rates after the introduction of base rate. At the same time, large corporations that earlier utilised their negotiating power and bargained with banks in order to obtain loans at sub-BPLR rates, could find it difficult due to the minimum rate fixed by banks.

What this means for banks?

Large banks that have higher percentage of low cost deposits and better operating efficiency will have a lower base rate and thus they will be able to price their loan products competitively. Small banks on the other hand will face problems in extending credit to large corporate. This would render a number of banks uncompetitive and enable big banks to increase their business.

Author: Praveen Bajaj, B.Com(H), MBA (SCMHRD)

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