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What is Base Rate, How it is Calculated, And its Effect on Bank Customers
17 June 2022
The Base rate is one of the more recent reforms implemented by the Reserve Bank of India (RBI). It was introduced on July 1, 2010, to replace the archaic Benchmark Prime Lending Rate (BPLR) and bring greater transparency to the pricing of bank loans, allowing for a more accurate assessment of monetary policy transmission.
In simple terms, the base rate is used as the banks’ internal benchmark rate for lending. As per the RBI norms, banks cannot offer loans at interest rates lower than the base rate set by the RBI. Read on to know more about the base rate system in India.
What is a Base Rate?
When you take a loan from a lending institution, there is an interest rate that is applied to the principal amount that you pay to the lender. A bank’s base rate is the lowest interest rate at which it will lend money to customers. Consider it a criterion below which the RBI does not allow banks to lend to customers. All banks are mandatorily required to set a base rate and charge interest rates based on the bank’s spread, the borrower’s credit profile, and repayment tenure.
The base rate includes all costs involved in the process of lending. The bank’s base rate system applies to all new and existing loans that are up for renewal.
Uses of the Base Rate System
The interest rate on all loan categories is determined primarily based on the base rate. Few exceptions are a DRI advance, loans to bank employees, and loans to bank depositors against their deposits.
The base rate could be used as a reference benchmark rate in addition to external market benchmark rates for floating rate loan products.
The base rate helps maintain transparency in the pricing of lending products, and it must be reviewed at least once a quarter. Banks must display the information on their base rate in all branches and on their websites.
How is the Base Rate Calculated?
A base rate is made up of different costs incurred during lending. Here are some of the factors that lenders take into account when setting the base rate:
A bank’s profitability in the previous fiscal year
A few other parameters with specified weights are considered
The cost of deposits is given the most weight in determining the new benchmark. Banks have the flexibility to consider the cost of deposits of any tenure when calculating their current base rate.
Who Calculates the Base Rate in India?
To ensure uniformity in the lending system, the Reserve Bank of India (RBI) sets the base rate for all banks in the country. Based on the RBI’s base rate, each bank can set its rate (not less than the RBI’s base rate) for different loan categories under the purview of RBI’s guidelines.
Banks may use any benchmark to calculate the base rate for a specific tenor, which must be disclosed in full. They are free to use any methodology they deem appropriate if it is consistent and available for supervisory review or scrutiny. At the bank’s discretion, borrowers will need to pay the base rate plus borrower-specific charges such as operating costs, credit risk premiums, and tenure premiums.
Each bank can set its own rate under the RBI’s guidelines and standards. According to RBI guidelines, it must include all the components of the lending rate that are common across various categories of borrowers. As we all know, the base rate varies from one bank to the next. However, the following four factors typically determine a bank’s base rate:
The cost of the funds i.e. interest rate given for deposits.
Operating costs associated with providing the loan product, such as the cost of raising funds.
The minimum rate of return (profit), as well as
The Cash Reserve Ratio or the CRR (Is the percentage of cash deposits that banks must keep with the Reserve Bank of India every two weeks) Currently, the CRR is 4.50%.
Current Base Rate of Banks in 2022
Andhra Bank/Union Bank
SBI (State Bank of India)
Bank of Baroda
Kotak Mahindra Bank
PNB (Punjab National Bank)
Union Bank of India
Syndicate Bank/Canara Bank
Corporation Bank/Union Bank
Bank of India
Oriental Bank of Commerce/PNB
Punjab & Sind Bank
Catholic Syrian Bank
Bank of Maharashtra
What are the Effects of the Base Rate?
Effect on Corporates: Large corporations benefited from rates as low as 4%-6% under the BPLR system. However, since the implementation of the concept of the base rate, no bank has been permitted to lend at a rate lower than the base rate. This has made corporate lending more expensive.
Effect on Retailers: The impact on a retail customer varies based on specific circumstances; it could be an increase or decrease of 25 basis points compared to their current rate of interest. Existing customers, however, will be unaffected by this change. (100 basis points = 1%)
The Benchmark Prime Lending Rate (BPLR) is the interest rate commercial banks charge their customers’ most creditworthy customers. The main issue was its lack of transparency. Banks could lend to privileged customers at rates lower than the BPLR. Each bank used its BPLR methodology, making it difficult for borrowers to compare rates across institutions.
In contrast, the Marginal Cost of Funds Based Lending Rate (MCLR) is determined by the current cost of funds. In contrast, in determining the base rate, the average cost of funds is considered. It also provides transparency in how banks determine interest rates on advances. Rates based on this system are more sensitive to changes in the policy rate.
MCLR and the base rate system are India’s most widely used rating systems and are based on the same principle to provide transparency. However, the base rate is calculated using the profit margin, whereas the MCLR is computed using the tenor premium.
The RBI introduced the base rate system in July 2010 to displace the archaic Benchmark Prime Lending Rate (BPLR) system to bring greater transparency to the pricing of bank loans. Banks have the freedom to set their base interest rates, subject to RBI guidelines, but this rate cannot be lower than the base rate designated by the RBI. Individuals or corporations can now access a transparent methodology of interest rate calculation when applying for a loan. The base rate system would apply to all new loans and renewals of existing loans. Existing loans based on the BPLR system may be serviced until maturity.
FAQs on Base Rate
Q1. How is MCLR different from the base rate?
Ans:The RBI introduced a new concept, Marginal Cost of Funds Based Lending Rate in April 2016. The MCLR is determined by the current interest rate given for deposits or the cost of funds. The base rate on the other hand, is determined by the average cost of funds.
Q2. What does the base rate influence?
Ans: The base rate will have an impact on the interest rate that consumers receive as banks will adjust their interest rates with respect to changes in the base rate set by the RBI.
Q3. How does the base rate affect existing loans?
Ans:Existing loans based on previous lending rates will run to their maturity with respect to the repo rates set by the RBI. When your loan is due for renewal, it will be priced using the base rate formula.
Q4. What is the RBI’s current base rate?
Ans: The RBI’s current base rate ranges from 7.25 per cent to 8.80 per cent (as of June 14, 2022).
Q5. Who decides the base rate for Indian banks?
Ans: The country’s central regulatory authority, the Reserve Bank of India, determines the base rate.
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Disclaimer: This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
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