Shift in regime- bank rate to base rate.
The new base regime has replaced the earlier bank rate. It was made effective from 1st July 2010 by RBI. It is mandatory for the commercial banks to follow the new base system which is believed to be more rational over the bank prime lending rate (BPLR).
So what is this change all about and how does it affect the borrowers?
Base rate is the minimum rate of interest or the floor below which no bank is allowed to charge from its customers (borrowers). Unless the RBI permits, no bank can lend at interest rate lower than the base rate. The base rate is believed to be more objective than BPLR primarily because of its calculation. It takes into account the cost of deposits, administration cost, and profitability— while pricing loans and risk will be charged over and above the Base Rate. The problem with earlier followed bank rate was that banks used to lend to its valuable and trustworthy clients at interest rate lower than the minimum rate i.e. bank rate. The reason was primarily the leeway and loopholes in the calculation of bank rate. Base rate can vary a little from bank to bank on account of tenure of cost of deposits. But other parameters won’t make much of difference.
It is the blue chip companies which will be affected by it because now they can’t enjoy benefits in terms of low interest on loans offered by banks. The base rate is such that there isn’t much scope for banks to reduce their interest rate further.
In the year 2009 several banks issued attractive home loan schemes and loan seekers made the most of the teaser rate schemes to buy their dream homes. They were fortunate to take advantage of the low fixed rates in the initial years of loan repayment. But the existing (old) customers were unfortunate as they could not reap benefits of low rates enjoyed by the new home loan seekers.
But after the introduction of Base Rate over BPLR the pricing of loan the scenario has changed. RBI has made it clear that any revision in the Base Rate will have to be passed on to the existing customers as well, which means that existing borrowers will stand to benefit from any reduction in interest rate. This means that now there will be symmetrical distribution of interest benefits among new and existing borrowers.
With the implementation of the Base Rate existing loan accounts will be migrated to the new structure with the customer’s approval. Teaser rate scheme borrowers can switch over to the new regime when their contracts come up for renewal once the initial fixed-rate period expires for no extra charges.
Under the base rate system, a bank cannot differentiate between an old borrower and a new borrower. Hence, it’s difficult for such teaser rate schemes to survive under the base rate regime. So now the special schemes come to an end.
The Reserve Bank of India, has said a bank will have to respect its fixed rate agreement, even if interest rates increase later on.
Clients of certain banks were scared that if the lender’s base rate went over the agreed fixed rate, the bank may hike the loan rate quoting RBI directives although the loan was called ‘fixed rate’. The RBI had ruled no loan can be given below the new base rate.
But RBI has said when contracting a fixed rate loan if the lending rate (as the special scheme) exceeds the base rate, banks need not charge higher rate. So an old customer paying fixed interest rate need not pay the revised rate if it exceeds their old interest rate.
It’s tough for a retail borrower to migrate to the base rate system as their loans don’t come up for renewal, unlike the corporate loans which are renewed every year. Hence, for retail loans such as home loans or personal loans, the bank will have to deal with customers on a case-by-case basis and help them migrate to the new benchmark subject to mutual consent.
About adjustments in base rate
As for the adjustments in the interest rates from time to time, RBI has given guidelines to banks to adjust their base rates depending upon the prevailing market conditions and interest rate policies. We can expect to see banks update their base rates every few months if that is required. Banks will then communicate this to all their clients.
However, one needs to remember that the Base Rate of different banks will not be the same. A borrower who finds another bank’s terms more attractive could always decide to make the switch.
Let us understand with the help of an example. If your interest rate is, 8.5% (Base Rate of 6% + spread of 2.5%), and it is 7.5% (5% + 2.5%) in case of bank B, the difference of 1% point could tilt your decision in favor of bank B.
At present, SBI’s base rate is 7.5 per cent. According to the Reserve Bank of India (RBI) norms, a bank will have to review the base rate at least once in a quarter. Other major banks like HDFC and ICICI have base rate of 7.25% and 7.5% respectively.