Two cheers for RBI

What was wrong with the earlier BPLR system?

Banks would resort to sub-BPLR lending,which meant that they would lend at rates below the BPLR. For instance,Home Loan Rate = BPLR less Differential. Now let us look at how this affected retail customers,specifically home loan borrowers. When interest rates within the economy fell,and competitors started offering home loans at lower rates,your bank would be forced to lower its rates too. But it would offer its new rates to new customers only. Older customers would have to continue paying the older,higher rates.

Technically banks would justify this move by keeping the BPLR intact. They would only increase the differential for the new customers.

But when rates were moving up,they would be quick to revise the BPLR. So the higher rates would apply immediately to older customers as well.

All these shenanigans meant that home loan customers who opted for floating rates were victims of an unfair system. EMIs moved up quickly when interest rates within the economy were moving up,but did not decline with the same alacrity when rates were declining.

How does this affect you?

Except in specific loan categories,banks will not be permitted to lend at rates below the base rate. This means that they will not be able to indulge in their favourite trick of keeping the BPLR unchanged while changing the differential for new customers.

How will base rate be calculated?

The base rate will be the sum of three components. One,it will depend on the cost of deposits. Two,banks keep a portion of their funds as CRR (cash reserve ratio) with the central bank on which they earn no returns. They also have to maintain a statutory liquidity ratio,which requires them to invest in treasury securities. The returns on these securities are typically lower than what they can earn by lending the money. To compensate for these notional losses,they will add a few percentage points while determining the base rate. And the third component will consist of overheads that banks bear.

What rate will you be charged?

The rate charged from you will depend on the base rate plus three other factors. Factor one is the cost of the specific loan that you are taking. This means that an unsecured loan such as a personal loan will cost more than a loan secured by a collateral,such as a home loan.

The second factor is individual-specific risk. Making use of data from credit bureau CIBIL,banks will offer a lower rate of interest to individuals with a better credit history and a higher rate to those with a poor credit history. The third factor will be the tenure of the loan: longer-tenure loans will carry a higher rate of interest.

Does this mean all’s well now ?

One will have to see whether banks accept the spirit of the new regulations and indeed make loan rates more transparent for both new and old customers,or whether they apply their considerable ingenuity to circumvent these new regulations.