Public RelationsRational, not administered
Business Standard / New Delhi October 23, 2009, 0:41 IST
The benchmark prime lending rates that banks use to offer a signpost to their lending rate structures have lost much of their significance and utility, thus prompting a study by the Reserve Bank of India (RBI) of what has been happening and inviting public discussion on proposals for a new system of base rates. The benchmark rates, which should reflect changes in the policy rates of RBI, have ceased to do so. Besides, sub-benchmark rates now abound, despite benchmark rates being based on the logic of prime lending rates which only the best customers of banks get. A key fallout from the present system is that retail customers of banks borrowing on floating rates, linked to benchmark rates, often do not see a positive impact on their rates of the RBI signalling a downward movement in interest rates. Therefore, the study has laid down a system of rationally calculating the base rate and the differentiations for different products, depending on the risks and costs they entail, which banks should follow and which should be the basis for fixing lending rates. Linked to this is the proposal that banks should refix their base rates every quarter and make them public, along with the minimum and maximum rates that go with the base rates.
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The actual formula for calculating the base rate has several elements — cost of funds, cost of complying with statutory requirements like SLR and CRR, overheads that cannot be allocated to different products and average return on equity. The markup on this for various products will depend on the costs of administering them and their risk perception. It is worth examining if the formula should be made obligatory to follow and not be recommended as a guide. The regulator could allow some flexibility in the method of calculation. A bank which gets its sums right should take minimal recourse to sub-base rate lending; one which does not will have to answer for itself and change its formula. The study also prescribes a maximum of sub-base rate lending in both priority and non-priority sectors to 15 per cent of incremental lending in a year (except credit cards and DRI loans), with a maximum 5 per cent allocated to non-priority sector lending. Again, laying down absolute figures may not be wise as it could act as a floor on lending rates. It may be better to treat the figure as indicative. A bank that crosses it need not be in breach of a rule but be asked to redo its base rate calculation.
The study sees the proposed system leading to certain outcomes on their own and not as a result of administrative fiat. Administered rates for loans below Rs 2 lakh can be ended and pegged to the base rate as that is the minimum at which a loan can be made by a bank without losing money. It will also be possible for banks to offer export credit at the base rate, which will be lower than the current benchmark rates. There is also a move to bring automaticity to administered educational loan rates by prescribing that they be fixed at 200 basis points above the average of the base rates of five leading banks. If a more rational and transparent system emerges from the proposed system, with fewer administered rates, then it will be a gain.