Details of Change of Lending Concept from BPLR to Base Rate by banks from July 2010


Meaning of BPLR

BPLR (Benchmark Prime Lending Rate) is the interest rate that commercial banks charge their most credit-worthy customers. According to the Reserve Bank of India banks are free to fix the Benchmark Prime Lending Rate (BPLR) with the approval of their respective Boards. The PLR is influenced by RBI’s policy rates – the repo rate, reverse repo rate and cash reserve ratio – apart from the bank’s policy. In simple words, availability of funds i.e. liquidity in the banking system and demand for credit by consumers (both retail and industrial) determine what the BPLR should be.

For lower grade borrowers like car loans etc., the lending rate normally may be at a suitable spread above the BPLR and for higher grade borrowers like credit sound corporate customers, the rate can be equal or less than BPLR. Upto 2 lakhs, the interest rate can be less than or equal to BPLR without any board approval. As per RBI report for the year 2008-09dt 27.8.2009, the commercial bank interest rates oscillated between 12.25 to 12.75% and at the year end of March 2009 it oscillated between 11 to 12% due to excess liquidity and less offtake by corporates as the corporates raised their money requirement from ECB.

For several years now, the majority of bank loans have been made at a discount to the BPLR — currently, more than 70% of all loans are below BPLR. This type of loan lower than BPLR is also called Sub-PLR loans. Most of the banks provide loans and advances at a rate lower than the BPLR (Prime Lending Rate) of the bank to customers availing finance for business purposes or short term funds for various needs but with good credit ratings. This enables them to attract large volume high end clients, offer bigger amounts of loans since the high credit worthiness is a likely indicator of customers making regular payments and in turn this helps the banks to increase business and get more profits from their loans.

Since banks are given the freedom to set the spread from the BPLR at whatever value they choose for new customers, they are able to provide attractive rates to new customers while continuing to charge a much higher interest rate for older customers. This is one of the main objections raised by old bank customers whenever loan rates are reduced for new customers by banks.

According to the RBI Annual Report (2007-08), in June 2008 the weighted average yield on loans of public sector banks was 100 basis points (bp) below the upper band of the BPLR; for private banks, it was 150 bp below the upper band of the BPLR. This was for loans in the aggregate. For corporate loans, the discounts to BPLR are even higher. Bankers say that, on the average, corporates are borrowing at around 12-12.75% in the F.Y.2007-08. This implies a discount of 400-450 bp to the BPLR in private banks and 200-250 bp at public sector banks for the said year. It is mostly in retail segments — two-wheelers, personal loans, credit cards — that banks are charging rates above the BPLR. There is no scientific method of charging the customers and hence RBI intervention was sought for remedial action.

BPLR normally determined by using marginal costing technique. For example, if the call deposits received by the bank carries an interest rate of 3%, then banks may think of lending it at 4.5% or 5% leaving 2% margin for their expenses and profit. So banks are having various lending rates based on various types of deposits received by it and tenure and rate of deposits.

Advantages of BPLR based lending

  1. Banks can lend funds to corporate and other clients at Sub-PLR rate in order to increase profitability and security of funds as huge turnover of funds in short term will compensate the difference in lending rates.
  2. Banks adjust Sub-PLR rates with higher lending rates on retail customers like credit cards, vehicle and housing loans.
  3. Banks funds will not remain idle as they can lend it at their own will after getting the approval of board in case of any lending below BPLR.
  4. Sound corporate got good bargaining loan rates and their profitability increased. Perfect competition existed among banks and corporates availed the benefits. No control of RBI on rates.
  5. External Commercial Borrowings (ECB)in which lending rate is very cheap is one of the factor which influences the bigger banks to lend at SubPLR rate and the BPLR based lending helps the banks to face the competition from overseas banks.
  6. Banks used this lending way in beneficial way even for short term loans in order to avoid parking funds with RBI at 3.25%.

Disadvantages

  1. Banks, in order to face competition from other banks, had to lower their lending rates below BPLR in order to retain clients and hence face competition from international banks which lends on ECB platform and the rate is very low. Since nowadays, most of the big corporate have become global companies, raising of funds from overseas banks is easy with the approval of RBI and positive Govt policies for raising loans outside India. Some of the banks in India suffered profit reduction due to this due to excess liquidity.
  2. Customers who are compelled to take loans in India only have to bear the brunt of higher than BPLR in order to compensate the loss to banks.
  3. Sound corporate clients are the beneficiary of this method commanding on banks to lend at cheaper rate for them though they got the capacity to bear the BPLR plus rates. Capacity to bear the rate is compromised in order to retain clients by banks.
  4. Discrimination of old customers’ vs. new customers existed almost in all banks. Banks, for example, give housing loans for lesser interest rates for new customers as compared to interest rate charged for the same period of lending to existing customers.
  5. RBI directed the banks to park the idle funds with it at 3.25% but banks resort to short term lending at higher rate thus beating the RBI policy of keeping control over funds in the market.

Due to complaints about indiscriminate lending rates by banks, RBI appointed a committee headed by RBI executive director Deepak Mohanty. He had suggested discontinuing the usage of a bank’s prime lending rate (PLR) as the benchmark for variable rate loans. Instead, he wants banks to arrive at a base rate that reflects the cost of one-year deposits and price loans over this base rate. The panel has also proposed a ceiling on the extent of loans that can be granted below the benchmark rate. Most banks typically pass on the benefit of falling rates only to fresh customers. RBI governor D Subbarao has repeatedly said though the central bank has slashed its repo rate (at which it lends to banks) by 425 basis points in the last one year, prime lending rates of banks have fallen by only around 200 basis points.

Finally RBI accepted the recommendation of Deepak Mohanty for discontinuing BPLR and in its place brought Base rate.

What is Base Rate?
It is a minimum rate for all commercial loans. Banks are not permitted to lend below this rate.
The criteria to be used for determining the base rate would be:

  1. Cost of deposits.
  2. Negative carry on cash reserve ratio/ statutory liquidity ratio; and
  3. Un-allocable overhead costs for banks.
  4. Banks would also add a profit margin to arrive at the base rate.

In fact, it is an aggregate pricing rate based on compounded deposit rate taking into account bank expenses whether it is direct or indirect and a profit element. Now liquidity, bank customer credit rating will not be criteria to lend below base rate. Banks cannot lend below base rate to any customer. Of course, the banks can lend at par at base rate to credit worthy corporate and hike this rate to other bank customers. So costing of various bank products is necessary to arrive at composite rate of bank deposits and also external cost of keeping funds with RBI and to follow certain statutory obligations.

The base rate will also result in increased transparency in pricing of loans as banks are supposed to exhibit the base rate. Banks will not overcharge any customers at the cost of another and SMEs will be the great beneficiaries. But banks can fix actual lending rates taking into account the credit risk of a borrower and the product.

Reactions from various bankers
Mr. Nair, Chairman of Indian Banks’ Association and CMD of Union Bank of India said that it would be game changer from BPLR to Base rate. It would bring more transparency in the system. He also said that the current practice of lenders arbitrarily quoting rates and borrowers demanding uneconomically low rates would go. Mr.AC Mahajan, Chairman of Canara bank said that the new system of base rate would help banks to price their loans more efficiently.

Mr.KR Kamath, Chairman and managing Director of Punjab National Bank commented that the banks are not the loser as they aim at fixed margin of profit overall. He also said that most loans given to small corporate like SMEs that were above PLR would get better reduced rates while those that were sub-PLR would see the rates going up. Further he added that the Cross subsidization of loans would come to an end and the base rate system would be a more scientific rate and bargaining with customer would be also scientific.

Mr.Narendra , Executive Director of Bank of India said that his bank would migrate to new system of pricing of loans and they were prepared for this. He pointed out that base rate would serve as the reference benchmark rate for floating rate products. JM Garg, CMD at Corporation Bank, said it’s a win-win situation for both banks and customers as banks cannot lend below their base rate and customers get a fair price, thereby doing away with the unhealthy competition in the system, which prevailed when banks used the BPLR to price their loans. “The move will bring in transparency as banks can now calculate their costs effectively,” he added. Garg said the base rate for public sector banks could be in the region of 9-9.5% and added that he could see a gain of 40-50 basis points for his bank.

Drawbacks likely to exists

  1. The new base rate may account for the cost of getting deposits but will ignore the cost of non-performing assets. But this can be covered under unallocated overhead costs by way of ‘non-performing asset rate’. Since Base rate is a new concept in Indian banking industry, some assumptions are to be taken in order to be within the criteria set by committee and it be reasonable enough to convince RBI, the watch dog of banking industry.
  2. The base rate will differ from bank to bank. It could be in the range of 7% to 9%. So weaker banks will have higher rate and find the going tough. The stronger ones will slowly absorb the weaker ones thus amalgamation of banks would be on the anvil. Competition among banks will reduce and ultimately bank customers may suffer if the banks are not prudent enough to curtail costs and overheads including NPA.

Benefits

Existing loan holders can opt for new loans which may be cheaper as compared to old one due to competition. The lowest interest base rate announced by bank like Indusbank , HDFC bank,Axis bank and ICICI bank which is 7.25% to 7.5%. T. SBI base rate is 8%. So in order to corner loan business from corporate clients, banks are reducing their base rate to the minimal and it is beneficial to business community especially SMEs . But in the long run, a cartel may be formed and interest rate may be hiked slowly and small fishes in banks will be swallowed by big fishes. Then there will be competition between govt banks and few private banks.

C.R. Venkata Ramani

(AICWA)

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20 thoughts on “Details of Change of Lending Concept from BPLR to Base Rate by banks from July 2010

  1. Hello Sir, I am having a loan account in HSBC and charging 15% [with BPLR as 17% and 2% discount]. Same bank is offering 12-13% as Base rate. Please let me know if it is a good advice to change.

    1. balance transfer to HDFC home loans & no charges from both bank however you will have to pay processing fee 0.5 % of the loan amount

  2. Dear Ram,
    I have taken home loan from HDFC (Not HDFC Bank). I approached them to convert my homeloan to base rate sytem. I was informed that, base rate is not applicable to HDFC Ltd. it is applicable to HDFC Bank (HDFC Bank doesn’t give Home loan, they redirect all requests to HDFC Ltd). HDFC Ltd is a NBFC and doesn’t come under the regulation of RBI rather under National Finanace Corporation. They follow RPLR and not BPLR.

    So my query is, how do they decide their RPLR. I have observed that they increase the interest rate, when RBI annource the CRR/Repo-rate/Reverse repo-rate etc. But don’t reduce the interest rate when RBI decreases the repo rate. If they are not governed by RBI, why do they do so? On what basis they increase their RPLR rate when they are nothing to with base rate or RBI?

    Instead they ask me to deposit Rs.11000/- to increase the -ve spread to have reduction in interest rate. I have already done this twrice by paying fee to increase the -ve spread.

    By paying Rs.11000/-, I will get -ve spread raised to -6% from current -4.5% and interest will come down to 9.25% from 10.75%.

    Request you to please answer my concern and advise me on excepting the -ve spread offere.

    Regards,
    HSahu

    1. Bank is right to say that BPLR is applied to banks only and not to Non-banking financial institutions like HDFC. As you are aware that any financial institution is working with peoples money or borrowed money. When the RBI base rate for lending to bank increases , automatically the banks lending rates increases. In similar way, banks are increasing their deposit rates. The non-banking financial institutions which gets money by inviting public deposit is also required to raise interest rates to be in competition with banks. So naturally it has to increase its lending rates to compensate for increase in deposit rates. All banks/financial institutions are living through net margin between lending rate and deposit rates. If you understand this, YOu can agree for the increase in rates of NBFC.Many financial institutions have their own calculation of negative spreads. I am not aware of the bank’s calculations. Anyhow, I think , either you can accept the bank’s demand or accept the higher rate of interest which may fluctuate from time to time. Now it appears that interest rates are peaked out and RBI will not increase further rates as it affects the growth of industries.

    2. RBI RPLR benchmark 17.50% howevere each NBFC decide their own RPLR which is gouverned by National housing board and RPLR changes whene there is change in CRR . HDFC offers fixed spread for whole tenure and spread is equel to discount so pay convertion charges and enjoy lower rate of interest.

    1. To my view, the base rate is applicable both for new fixed rate loans and floating rate loans after the deadline of july 20101. No bank can give loan lower than base rate whether it is for fixed or floating rate. But once fixed rate is agreed for certain tenure which is above the base rate, it cannot be changed till the tenure of fixed rate is over even if the base rate changes upwards or downwards. This is RBI direction .

  3. Dear Mr.Venkat

    It is really a wonderful article from basics to consequences.

    As you are aware, BASEL III will be announced during Dec, 2010 and all banks implemented BASEL II norms.
    As mentioned in the article, the rating is not necessary to get the better rate against the BASE rate. If the borrowers preferred to opt out from rating, how the bank will implement the BASEL II NORMS.

    Kindly through some light on this issue.

    V.Senthilnathan

    1. When bank entered into a contract with a client, it cannot change it arbitrarily and it has to abide by the terms and conditions of contract entered into.The bank cannot insist on new rules unless old rules go against constitutional law. The new norms etc. will be applicable only to new loanees.

  4. Hi,

    I have a homeloan linked to BPLR and runs at 8.75% floating..
    Now with the existense of Base rate, what will happen to the 8.75% floating rate??

    I mean how will my 8.75% float with no BPLR system?
    I dont see any BPLR linked interest rates on my Bank Website..everything is moved & shown as per base rate..

    So does this mean that my 8.75% floating rate is fixed now? until i or bank decides to force me to base rate??

  5. Kindly see this site very often so that you can see latest articles from time to time. You can inform your friends also about this free site so that they can also get some benefits.

  6. That’s an excellent explanation on BPLR & Base Rate to understand by laymen.

    It is not clear, explicitly, whether private banks are going to offer the option of base rates for the old borrower and if so, will there be any relief in interest rate which was based on BPLR earlier?

    Regards,
    Kishore

    1. Dear sir, Ofcourse. Banks have to consider the request. Before applying to banks, please find out from banks about their base rate . You can add 1% to 1.5% to it as bank margins. If this rate is less than your loan interest, you can approach your banker for reduction of interest. Have a dialogue with your banker telling the term of your loan also so that they can advice you properly for switch over if profitable.

      venkat

  7. All of Mr. Venkata Ramani’s post are listed here on this blog, you can visit any of these on this blog itself. You can filter the article like by author to get his selective articles.

    Cheers!
    Ram

  8. dear sir,
    this is an excellent article of your’s and a very good explanation given by you to a person new in this feild.
    i would like to request you to mail me all your articles and circulars

    regards,
    sandeep

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