Know about Base rate?

RBI has proposed to replace the Benchmark Prime Lending Rate (BPLR) with base rates from 1 july 2010 . The base rate is the lowest rate that the bank can charge from a customer and is intended to bring about more transparency in the lending operations of banks.

How BASE RATE is calculated?

The Base Rate is computed by considering the following parameters

• Bank’s cost of deposit (which is taken as the benchmark).
• Negative carry on maintaining Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio. (CRR)
• Administrative expenses, which cannot be specifically attributed to any particular type of lending, and
• Average expected return on capital employed for supporting the lending activities

The final lending rates have been arrived at by adding borrower specific charges, tenure premium, credit risk premium etc to the Base Rate.

The Base Rate and final lending rates will be reviewed / revised by the Bank at least once in a quarter

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Before setting the base rate system, banks used another rate system called Prime Lending Rate (PLR) to set their lending rates. The problem with this system is, banks manipulated this PLR to lower level to offer discounted lending rates for the borrowers. It may cause the loss for the banks if they offer loan with much cheaper price. The real intention of the RBI is to make the banking system much stronger after the global financial crisis.
The banks meet huge loss because of the default loans. The main reason is, when banks offer loans with cheaper price to lure the customers, most of the customers without adequate financial support too get the loans. It will end in default (can not repay the loans). Base rate system provides more transparency on setting the rates. Each bank use some criteria to set their base rates.
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What is Base Rate System?

As I have mentioned in the previous section, Base Rate System is for the banks to set a level of minimum interest rates charged while giving out the loans. This Base Rate System has many advantages over the older method of Prime Lending Rate (PLR).  One advantage is, in the Prime Lending Rate (PLR), one could sanction the loan for lower price for the preferred customer or the corporate bodies and retail customers may have to pay more for the same type of loans. In the base rate system, there will not be much variance on the loans.
However, the base rate system will not be applicable for the following type of loans:

• Agricultural Loans
• Loans given to own employees
• Loans against deposit
• Export Credit

Base rate system is arrived at taking into the account, the cost of deposits and cost of keeping aside cash to meet CLR and SLR. It is convenient for the banks to adjust the lending rates after the changes on policy rates by the RBI.

Unlike the BPLR that was set somewhat arbitrarily by banks, the base rate will follow an explicit formula that factors in a bank's cost of deposits, operating costs (expenses of running its branches, for instance), the cost of statutory drafts on bank funds imposed by the Reserve Bank of India (the Cash Reserve Ratio and Statutory Liquidity Ratio) and the profit margin.
The base rate will help borrowers to compare interest rates offered by various banks and make the process of how banks arrive at interest rates for loans more transparent.
RBI has stipulated that banks cannot charge below the base rate for most loans. (There are a couple of exceptions like agricultural loans and export credit.) While the new model will ensure greater transparency, it need not mean lower lending rates for borrowers.