Base Rate-New System of Loan Pricing by Banks in India-VRK100-13062010

BASE RATE -
NEW SYSTEM
OF LOAN
PRICING BY
BANKS IN
INDIA
Rama Krishna Vadlamudi, BOMBAY June 13, 2010
ABBREVIATIONS USED:
BPLR : Benchmark Prime Lending Rate
BRS : Base Rate System
CASA : Current Account and Savings Bank Accounts (low-cost deposits)
CD : Certificate of Deposit; CP : Commercial paper;
CRR : Cash Reserve Ratio; DRI : Differential Rate of Interest
G-Sec : Government Security
LAF : Liquidity Adjustment Facility of the RBI
MIBOR : Mumbai Inter-bank Offered Rate
PLR : Prime Lending Rate
RBI : Reserve Bank of India; and, SLR : Statutory Liquidity Ratio
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EXECUTIVE SUMMARY
Come July 2010, the Indian banking sector is going to witness some
fast moving and high-impact developments. India’s banking regulator,
Reserve Bank of India, is ushering in a new Base Rate System (BRS)
replacing the existing, outdated and non-transparent Benchmark Prime
Lending Rate (BPLR) system. At present, sub-BPLR lending is rampant
in the system. Once the new BRS comes into effect, one expects that
such a non-transparent and discriminatory system will come to an end.
RBI, in April 2009, announced the appointment of a working group to

study the relevance of the existing BPLR and suggest ways to improve
the system. The Working Group, headed by Deepak Mohanty,
submitted its report in October 2009. Based on the recommendations of
the working group, RBI released its draft circular on BASE RATE
system on February 10, 2010. After getting feedback from banks and
other stakeholders, RBI had issued its Final Guidelines on April 9, 2010.
The new Base Rate System would be effective from July 1, 2010.
The Committee’s recommendations have been partially accepted by

RBI. In future, banks will not be able to lend at rates below the Base
Rate. The Base Rate will be based on the bank’s cost of deposits/funds,
negative carry on SLR/CRR, unallocatable overhead cost and average
return on net worth. The actual lending rate to be charged to borrowers
will be Base Rate plus product-specific overhead cost, credit risk
premium and tenor risk premium.
So far, no bank has announced its Base Rate. They may announce the
Base Rates in the next few weeks before the deadline of July 1, 2010.
The author expects the Base Rate range to be between six and nine per
cent due to wide differences in cost of funds, NPAs and other costs.
This article examines, in a comprehensive manner, the contents of the

report of the working group and the RBI’s Final Guidelines issued on
April 9, 2010. The author has tried to bring in all the aspects of the new
system in a simple and easy language that is understandable by all. The
article is written in a question-and-answer format, which is one of the
easiest. The article’s highlights are:
Page 2 of 20
Why is RBI switching over to the new Base Rate System

What will be the impact of the new system
What are the RBI’s Final Guidelines
Whether RBI has accepted the Committee’s recommendations fully
What are the differences between the Committee’s
recommendations and RBI’s Final Guidelines
How is the Base Rate calculated
How is the actual lending rate worked out
What is the likely range of Base Rates by banks
At the end, the following annexures are provided for additional reading:
I : Full recommendations of the Deepak Mohanty Committee

II : Formulas for calculating the Base Rate
III : TIMELINE: Evolution of BPLR since the early 1990s to 2004
IV : Some important terms explained
1. What is Base Rate?
Base Rate is the minimum lending rate below which a bank can not lend to
borrowers except in a few cases. Base Rate is being implemented in India with
effect from July 1, 2010. From that date, the existing Benchmark Prime Lending
Rate (BPLR) will cease to exist and the new Base Rate System will come into
effect. Base Rate will differ from bank to bank depending on individual bank’s
cost of deposits/funds and other criteria.
2. Why is RBI changing the loan pricing system?
There is a public perception that banks have been offering lower lending rates to
big corporate customers, while charging higher rates from small borrowers in the
retail, small business and agriculture segments. This amounts to cross-
subsidization. RBI has received several complaints to this effect from various
industry bodies and associations. RBI has taken this view into consideration. For
several years especially since the early 2000s, RBI had tried to bring in a
transparent system of lending rates in the banking system. After trying very hard,
RBI has genuinely felt that banks’ BPLRs are not transparent and there is a
large-scale sub-BPLR lending.
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Downward stickiness in rates: RBI has observed that whenever RBI raises policy
rates and reserve ratios, banks are quick to increase their loan rates. But, when
RBI reduces policy rates and reserve ratios, banks respond very slowly effecting
decreased lending rates with a considerable time lag. Such a phenomenon is
called downward stickiness in rates. RBI is of the view that it is adversely
impacting the monetary transmission mechanism in the banking system.
Due to competition, banks have been offering loans to first class borrowers with
high credit rating at rates much below the BPLR in a non-transparent manner.
RBI opines that banks’ lending at sub-BPLR rates is not in tune with the central
bank’s objective of bringing transparency to the loan rates. BPLR has fallen short
of RBI’s expectations to work as a reference rate or benchmark rate.
Keeping the above in mind, RBI had set up, in April 2009, a committee under the
chairmanship of Deepak Mohanty to look into the existing BPLR system and
suggest a suitable alternative system for pricing bank loans. The Deepak
Mohanty Committee’s recommendations were made public in October 2009,
which suggested shifting from the current BPLR to a new system called Base
Rate System. After getting feedback from banks and other stakeholders, RBI had
issued its Final Guidelines on April 9, 2010.
3. What are Deepak Mohanty Committee’s Recommendations?
The important recommendations are:
The concept of BPLR is outdated and is out of sync with the present market
conditions and it should be replaced with a new Base Rate System
Base Rate would be based on one-year card rate on deposits, loss incurred
by banks for SLR/CRR, overhead cost and average return on net worth
The actual rate charged to borrowers would be Base Rate increased by

operating costs, credit risk premium, tenor premium and others
Banks should not lend below the Base Rate, except in a few cases
At present, the Government administers loans of up to Rs 2 lakh to small

borrowers, under priority sector & others. These administered rates shall be
discontinued and these loans can be brought under the Base Rate system.
(For full set of recommendations, see Annexure I at the end of this article.)
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4. Whether RBI has accepted the recommendations?
RBI had made public the report of Deepak Mohanty Committee in October 2009.
After getting feedback from banks, RBI had issued the final guidelines on Base
Rate System on April 9, 2010.
RBI’s Final Guidelines on Base Rate are as follows:
All scheduled commercial banks should switch over from the existing BPLR
system to the new Base Rate System
Base Rate System is to be implemented from July 1, 2010
Banks may choose any benchmark to arrive at the Base Rate for a specific
tenor (tenure of the loan)
Banks are free to use any other methodology, provided it is made available for
RBI’s scrutiny
All loans and advances should be linked to Base Rate. But, there are a few
exceptions meaning the following loans can be disbursed without linking them
to Base Rate:
i. DRI advances
ii. Loans to banks’ own employees
iii. Loans to banks’ depositors against their own deposits
Effectively, it means banks can lend below Base Rate in the above cases.
Actual lending rate will be based on Base Rate plus customer specific charges
Until the new system stabilizes, banks are given flexibility to change the
benchmark and methodology any time between July and December 2010
Base Rate can be used as a reference rate for floating rate loans
The current stipulation of BPLR as the ceiling rate for loans up to Rs. 2 lakh,
under priority sector and others, stands withdrawn wef July 1, 2010
RBI will separately announce lending rates for export credit (The details are
given elsewhere)
Banks have to review Base Rate on a quarterly basis
Page 5 of 20
The Base Rate system will be applicable to new loans as well as loans that
have come up for renewal
Banks shall exhibit the information on Base Rate on their websites and at all
their branches
The RBI’s circular on final guidelines is a watered-down version of the Deepak

Mohanty Committee’s recommendations. The following table will help the reader.
Deepak Mohanty Committee RBI's Final Guidelines

(RBI circular dated April 9, 2010)
recommendations
Base Rate should not be linked to the RBI has not granted any exception to these
following loans, namely, (i). loans to two types of loans
selective credit control and,
(ii). credit card receivables
Base Rate should be applicable to loans No such stipulation by RBI

with maturity of more than one year
For loans below maturity of one year, banks No such stipulation by RBI
are free to charge rates without any link to
Base Rate
Interest rates on export credit should not RBI has stated that export credit should be
exceed Base Rate at or above Base Rate
Educational loans should be administered No such special treatment to Educational

& their rates should not exceed Base Rate loans
plus 200 basis points
Base Rate should be calculated based on Base Rate should be calculated based on
one year deposit rate adjusted for CASA cost of deposits/funds and other criteria.
deposits and other criteria
As can be seen from the above table, RBI has accepted the Committee’s
recommendations only partially. For calculating the Base Rate, RBI has given
greater flexibility to banks with regard to selecting a benchmark and calculation
methodology.
5. How is Base Rate different from BPLR?
Under the existing Benchmark Prime Lending Rate (BPLR), banks can give loans
below BPLR, called sub-BPLR lending. In fact, as at the end of March 2009, 67
per cent of total loans in the entire banking system were contracted at below
Page 6 of 20
BPLR. This is not possible under the new Base Rate System. Banks are not
allowed to lend at below Base Rate. It is the minimum lending rate banks have to
charge to their customers. However, there are a few exceptions to this rule (the
details are given elsewhere).
6. How is Base Rate calculated?
Banks are given freedom to decide their own Base Rates based on cost of
deposits, adjustment for CRR/SLR maintenance, unallocatable overhead costs
and average return on net worth.
According to RBI, Base Rate shall include all those elements of the lending rates
that are common across all categories of borrowers. Banks may choose any
benchmark to arrive at the Base Rate for a specific tenor to be disclosed
transparently. An RBI illustration, for computing the Base Rate is given below:
BASE RATE
=
Cost of deposits/funds
+
Negative carry on CRR/SLR
+
Unallocatable overhead cost
+
Average return on net worth
Banks are free to use any other appropriate methodology, provided it is

consistent and is made available for RBI review/scrutiny.
Strictly speaking, the above is only for illustrative purposes. RBI has given
freedom to banks to use their own methods for the calculation of Base Rate.
(The above terms are explained with formulas in Annexure II at the end.)
Page 7 of 20
7. Will customers be able get loans at Base Rate?
RBI says that banks can calculate the actual lending rate by adding customer
specific charges to the Base Rate.
Frankly speaking, Base Rate is not equal to lending rate that will be charged
ultimately to the customer. While arriving at the actual lending rate, banks will
add certain appropriate charges specific to the customer, like overhead costs,
credit risk premium and tenor premium. As per the Deepak Mohanty Committee’s
report, actual lending rate can be arrived at as follows:
Actual lending rate *

=
Base Rate
+
Product specific operating cost
+
Credit risk premium
+
Tenor premium
* Actual lending rate that will be charged by banks to the borrowers
Credit risk premium: All loans carry credit risk meaning that the borrower may fail
to repay the loan. The extent of credit risk differs from one borrower to another
borrower depending on the borrower’s overall credit standing and other factors.
So, the credit risk premium may be lower for a customer with good track record
and may be higher for customers with not-so-good record.
Tenor premium: In general, the longer the maturity of the loan, the higher the risk
for a lender. As such, banks usually charge higher rates for long-term loans
compared to short-term loans, other things being equal.
Page 8 of 20
Example: As all loans will be linked to Base Rate, whenever a bank changes its
Base Rate, the loan rates of customers will change accordingly. Suppose Bank
Efficient has kept its Base Rate at 8 per cent. And the Bank Efficient has fixed
car loans at Base Rate plus 4 per cent (ie, 400 basis points), the car loan rate will
be 12 per cent (8 + 4). After a few months, Bank Efficient has revised the Base
Rate to 9 per cent, the car loan rate will be revised to 13 per cent (Base Rate
plus car loan premium = 9 + 4). Moreover, the Bank has got freedom to revise
the car loan premium. Depending on the market conditions and other
considerations, the Bank may decide to increase the loan premium to 5 per cent
from 4 per cent. Then, the car loan rate will be revised to 14 per cent (9 + 5).
8. What is transparency in loan pricing?

Transparency in bank lending means that banks should be able to provide
adequate information to borrowers so that the latter fully understand the terms
and conditions. Higher levels of transparency can be achieved by disclosing
information on how the loan rates are arrived at by the bank. Transparent lending
is equal to borrowers correctly understanding the loan pricing mechanism and
other fees before signing the loan agreement. Banks should not indulge in
charging any hidden costs and unexpected rate increases. To achieve greater
levels of transparency, banks shall ensure that all charges and possibility of rate
increases are made clear to the borrower at the beginning of the agreement.
Given the large proportion of sub-BPLR lending by the banking system, concerns
have been raised on the transparency aspect of computation of BPLRs by banks.
9. What is monetary policy transmission?
Whenever RBI raises or lowers policy rates, banks are expected to revise their
interest rates in tune with the RBI. The intentions of RBI will be carried through
the commercial banks to the entire economy. Banks pass on the RBI’s policy
measures either by increasing the lending and deposit rates or by lowering them
in tune with the RBI’s policy measures. This is called Monetary Policy
transmission. But, this monetary transmission is not happening in actual practice
due to a variety of reasons. Banks usually respond with a considerable time lag
to the changes in RBI’s policy rates. Whenever RBI raises policy rates, it is
observed that banks raise their lending rates immediately. However, when RBI
lowers policy rates, banks act slowly and lower their loan rates with a substantial
time lag. Such downward stickiness in rates is creating problems for RBI in its
objectives of achieving price stability and growth.
Monetary policy transmission is the responsiveness of the banking system to the

changes in the monetary policy of the RBI. RBI raises policy rates and reserve
ratios or decreases them depending on the macro economic conditions, inflation
rate, government policies and others.
Page 9 of 20
10. What type of customers can get loans at below Base Rate?
As stated above, there are a few exceptions to Base Rate rule which forbids
banks from lending below Base Rate. In the following cases, RBI has permitted
banks to fix rates without linking them to Base Rate:
1. Loans under the DRI scheme

2. Loans to banks’ own employees
3. Loans to banks’ depositors against their own deposits
11. What will be the advantages of Base Rate System?
RBI has decided to replace the BPLR with Base Rate to make credit
pricing more transparent
It is expected that higher transparency will benefit all kinds of borrowers

irrespective of the size of the loan
The Base Rate system is aimed at enhancing transparency in lending rates of

banks and enabling better assessment of transmission of monetary policy
12. What will be the impact of the new method?
The biggest impact is that the new Base Rates from commercial banks will be
much lower than the existing Benchmark Prime Lending Rates (BPLR). Due to
heavy competition in the industry, some aggressive banks, whose cost of
deposits/funds is lower compared to industry levels, may peg their Base Rates
very low.
The new Base Rate System (BRS) is expected to impact the banks in different
ways depending on their cost of deposits, overhead cost, their customer profile,
geographical concentration and others. Likewise, the BRS will impact the debtors
in various ways.
One biggest benefit with the BRS as cited by policymakers and experts is that it
will help the Reserve Bank of India to transmit the changes in policy rates (Repo
and Reverse Repo under LAF) in a better manner. Under the BPLR, monetary
policy transmission is weak due to lack of transparency in BPLR. This has been
brought out elaborately by Deepak Mohanty Committee’s Report. Now, with the
BRS, RBI expects that banks will respond immediately to RBI’s policy rates.
Page 10 of 20
Let me try to briefly examine the impact of BRS:
The Base Rate System is expected to usher in a transparent system

meaning borrowers will be able to understand how their loan rate is
arrived at
After the implementation of Base Rate, banks will stop fresh lending below
their BPLRs as they shift to Base Rate System
Highly-rated companies have been borrowing at sub-BPLR rate for a long
time due to competition among banks and this practice may come to an
end after the Base Rate kicks in
Once BRS comes into effect, rates for short-term bank loans to
corporates could rise. However, large and reputed companies with strong
balance sheets may explore Commercial Paper (CP) route. Hence, the
BRS may not change loan rates for big companies, like, RIL, L&T, ONGC,
as they have direct access to CP or bond markets.
Small and Medium Enterprises (SMEs) may get favourable rates. The
impression in public that SMEs and small borrowers are subsidizing the
corporate loans. This type of cross-subsidization will stop from now.
This is a step towards further deregulation of interest rates as banks will
stop giving concessional rates to loans below Rs 2 lakh (especially priority
sector loans up to Rs 2 lakh). RBI has given freedom to banks to charge
commercial rates for loans below Rs 2 lakh at rates linked to base rate.
With this, RBI wants to increase the credit flow to small borrowers.
It remains to be seen how the Base Rate will impact the credit offtake. As of now,
credit growth is sluggish due to a variety of reasons. As banks will not be able to
lend below Base Rate, corporates will turn toward Commercial Paper route and
banks may not be able to lend their surplus funds in the short term. One piquant
situation may be that borrowers with ‘AAA’ rating will approach the markets
through the Commercial Paper (CP) route. Banks will invest in these CPs and
such lending through CP route will not be part of their ‘Advances,’ but part of
‘Investments.’
Alternatively, banks may be tempted to park their surplus with the Reverse Repo
window of the RBI’s LAF or invest in G-Secs or liquid schemes of mutual funds.
13. To what kinds of Banks the Base Rate is applicable?
The Base Rate is made applicable by RBI to all scheduled commercial banks
(ASCBs) in India, except Regional Rural Banks (RRBs).
Page 11 of 20
14. Whether banks have fixed their Base Rates?

So far, no bank has fixed its Base Rate. Another two weeks time is available for
banks to announce their Base Rates before the deadline of July 1st. State Bank
of India, India’s biggest lender, has indicated that it may link its Base Rate to cost
of deposits and the Base Rate may be around eight per cent. Average cost of
deposits for SBI is 5.80 per cent as on March 2010. And its cumulative net
interest margin (NIM) is 2.66 per cent for the financial year 2009-10.
Union Bank of India has hinted that it may set the Base Rate between 8.25 and
8.75 per cent. According to rumours, it seems HDFC Bank is likely to fix its Base
Rate at around six per cent. It may be noted that its Net Interest Margin has
traditionally been much higher at around 4.0 per cent. In fact, for the year 2009-
10, the net interest margin is 4.3 per cent for the bank. This is due to very low
cost of deposits, which is at 4.7 per cent for 2009-10.
Overall, the Base Rate range may be between six and nine per cent for most of
the commercial banks initially.
15. What is the lending rate for export credit?

In its circular dated April 9, 2010, RBI had stated that it would announce the rates
for export credit separately. And as promised, RBI had issued a circular on April
23, 2010 stating that banks should fix their lending rate to export credit (both pre-
shipment rupee export credit and post-shipment rupee export credit) at or above
the Base Rate. The revised instructions will be effective from July 1, 2010.
16. Why is sub-BPLR rampant in the banking system?

Keeping in view the international practice and to provide further operational
flexibility to commercial banks in deciding their lending rates, RBI in April 2001
decided to make PLR a benchmark rate. Accordingly, commercial banks were
allowed to lend at sub-PLR rate for loans above Rs.2 lakh. In 2003, RBI replaced
the PLR system with BPLR. In the beginning, it was expected that sub-BPLR
lending would be marginal. But from 28 per cent of total bank credit in March
2002, sub-BPLR lending had gone up to 77 per cent in September 2008 before
declining to 67 per cent in March 2009.
On account of competitive pressures, banks were lending a part of their portfolio

at rates below their BPLRs. A large loan offered to a highly rated borrower may
be offered at a lower rate below the current all-in-cost BPLR due to little risk and
savings on account of processing and monitoring costs. Although justifiable to
some extent, such sub-BPLR lending on a large scale has created a perception
that large borrowers are being cross subsidized by retail and small borrowers.
(The timeline for the evolution of PLR/BPLR system is given in Annexure III.)
Page 12 of 20
17. What is downward stickiness in rates:
The Working Group has observed that whenever RBI raises policy rates and
reserve ratios, banks are quick to increase their loan rates. But, when RBI
reduces policy rates and reserve ratios, banks respond very slowly effecting
decreased lending rates with a considerable time lag. This is called downward
stickiness in rates. RBI has opined that this downward stickiness is adversely
impacting the monetary transmission mechanism in the banking system.
One of the major reasons for downward stickiness is the large share of deposits
(major portion consists of term deposits with fixed tenure) contracted at high
rates in the past. In response to RBI’s reduction of policy rates, banks are not in
a position to reduce their lending rates as their cost of funds will remain high for
quite some time during the early part of a declining interest rate environment.
The marginal cost of funds is more relevant for banks for pricing current
loans/advances rather than the average cost which is computed on the basis of
the cost of all outstanding purchased and borrowed liabilities reflected in the
balance sheet.
The downward stickiness in BPLRs is also attributed to several other factors

such as (i) the administered interest rate structure on small savings, which
constrains the reduction in deposit rates; (ii) concessional lending rates linked to
BPLRs for some sectors, which make overall lending rates less flexible; and (iii)
persistence of the large market borrowing programme of the government, which
hardens interest rate expectations.
18. What is the criticism of the Base Rate System?
The new Base Rate System has received more brickbats than bouquets from
several industry watchers:
U.R.Bhat, Dalton Capital Advisors: “The prohibition from lending below the
base rate virtually bids goodbye to the principles of free market…Banks
may need to lend short-term to low-risk borrowers at rates below the Base
Rate depending on the market conditions…” (Economic Times, March 8,
2010).
Saurabh Mukherjea, Noble Group: “Seventy per cent of the Indian banking
system is in the hands of public sector banks. These banks’ profits will
come under pressure as the interest rate cycle moves north…Hence, by
diminishing the intensity of competition in the banking sector, RBI is taking
care of the interests of public sector titans like the State Bank of India and
Punjab National Bank…” (Outlook Profit, 2nd April 2010)
Page 13 of 20
19. CONCLUDING REMARKS
The Base Rate System is only starting from July 1, 2010. The RBI has given a
cooling period of six months till December 31, 2010, which gives banks flexibility
to experiment with various calculation methods and Base Rates, before settling
for a particular method or a specific Base Rate. As such, the system will evolve
over a period of time.
We can definitely expect some more changes to the Base Rate System once RBI
gets a feel of the new system. Banks have been smart players and they have
been making good profits notwithstanding the global financial meltdown of 2008
and the wild movements in interest rates.
It is expected that banks will be able to protect their margins despite the Base
Rate System, unless more banking licenses are given by RBI/Government.
India’s Telecom Sector has witnessed intense competition in the last two to three
years and this has benefited the customers immensely due to steep reduction in
telephone tariffs. The competition in Telecom Sector has widened the market
base and this has brought higher revenues for the Government in the form of
service tax, corporate tax and income tax.
Can we expect that the same thing will happen in the banking sector?
It may not happen in banking sector until more banking licenses have been
issued to both the private sector and public sector players. In this backdrop, it
remains to be seen whether the twin objectives of RBI of bringing in better
transparency and improved monetary policy transmission will be achieved.
Moreover, it will be interesting to watch the response of the market, banks,

stakeholders, RBI and the Government to this new development.
Page 14 of 20
ANNEXURE I
REPORT OF THE WORKING GROUP ON

BENCHMARK PRIME LENDING RATE HEADED BY DEEPAK MOHANTY
The Working Group had the following terms of reference:
(i) to review the concept of BPLR and the manner of its computation;
(ii) to examine the extent of sub-BPLR lending and the reasons thereof;
(iii) to suggest an appropriate loan pricing system for banks based on
international best practices.
The Committee’s observations and recommendations:
1. The concept of BPLR is outdated and is out of sync with the present
market conditions
2. BPLR system is not very effective in achieving the objectives of RBI in
terms of monetary policy transmission
3. BPLR system lacks transparency
4. Due to distortions in the BPLR, banks were lending at rates much below
the BPLR thus defeating principles of commercial judgment
5. A new system called BASE RATE should be introduced replacing the
existing BPLR
6. Base Rate would be based on the following:
i. The card interest rate on retail deposits (deposits below Rs

15 lakh) of maturity of up to one year (adjusted for CASA
deposits)
ii. Loss incurred by banks for maintenance of CRR and SLR
iii. Overhead cost of banks
iv. Average return on net worth
7. The actual rate charged to borrowers would be Base Rate increased by
operating costs, credit risk premium, tenor premium and others
8. Banks should not lend at rates below the Base Rate
9. However, the following exceptions may be given to the above rule,
meaning, banks can charge interest rates below the Base Rate for the
following types of loans:
i. Loans pertaining to selective credit control

ii. Credit card receivables
iii. Loans to own employees
iv. DRI loans
Page 15 of 20
10. Base Rate System would be applicable for loans with maturity of one year
and above (including working capital loans)
11. Banks may give loans for periods of less than one year at fixed or floating
rates without reference to Base Rate subject to certain conditions. In this
regard, the Committee has recommended certain ceilings for such sub-
Base Rate lending.
12. Base rate shall be the basis for floating rate loans also. Banks may use
Base Rate or any external market-based benchmark rates (like, G-Sec,
Repo rate, MIBOR, CP, CD etc).
13. At present, the Government administers loans of up to Rs 2 lakh to small
borrowers, under priority sector and others. This administered regime shall
be discontinued and these loans can be brought under the Base Rate
system.
14. Interest rate on rupee export credit should not exceed Base Rate
15. Educational loans should be given a special exemption and they should
continue to be administered. Interest rate on educational loans should not
exceed Base Rate plus 200 basis points.
16. Banks should pass on the information about Base Rates to the public
through their websites
ANNEXURE II
Mathematically, the Base Rate is calculated as follows as per RBI’s illustration:
Base Rate = a + b + c + d
a = cost of deposits/funds = CoD
b = Negative carry on CRR and SLR
[ CoD – (SLR x Tr)]

= ----------------------- x 100 – CoD
[1 – (CRR + SLR)]
Uc
c = Unallocatable overhead cost = ------ x 100
Dply
Page 16 of 20
NP NW
d = Average return on net worth = ------ X ------ x 100

NW Dply
Where,
D = Total Deposits = Term deposits + Current a/c deposits + Savings deposits
Dply = Deployable deposits

= Total deposits less share of deposits locked in SLR and CRR
= D x [1 – (CRR + SLR)]
CRR = Cash Reserve Ratio
SLR = Statutory Liquidity Ratio
Tr = 364-day Treasury Bill rate
Uc = Unallocatable overhead cost
NP = Net profit
NW = Net worth = Capital + free reserves
Negative carry on SLR and CRR: At present, SLR is 25 per cent and CRR is 6
per cent. CRR balance does not provide any return to banks; while the return on
SLR balance is lower than the cost of deposits. As such, SLR and CRR carry
negative returns for banks.
Unallocatable Overhead Cost: It is fixed overhead cost consisting of Head Office

and Corporate Office costs, which cannot be allocated. Examples of such
overhead costs are: aggregate employee compensation relating to administrative
functions in corporate office, directors’ and auditors’ fees, legal and premises
expenses, depreciation, cost of printing and stationery, expenses incurred on
communication and advertising and IT spending, etc.
Page 17 of 20
ANNEXURE III
Evolution of BPLR in India : A Snapshot
Early 1990s
Till the early 1990s, deposit and lending rates were mostly administered by RBI. In the early
1990s, RBI started deregulating deposit rates and lending rates.
October 1994
Lending rates for loans with credit limits of over Rs. 2 lakh deregulated. Banks were required
to declare their Prime lending rates (PLRs).
February 1997
Banks allowed to prescribe separate PLRs and spreads over PLRs, both for loan and cash
credit components.
October 1997
For term loans of 3 years and above, separate Prime Term Lending Rates (PTLRs) were
required to be announced by banks.
April 1998
PLR converted as a ceiling rate on loans up to Rs.2 lakh.
April 99
Tenor-linked Prime Lending Rates (TPLRs) introduced.
October 1999
Banks were given flexibility to charge interest rates without reference to the PLR in respect of
certain categories of loans/credit.
April 2000
Banks allowed to charge fixed/floating rate on their lending for credit limit of over Rs.2 lakh.
April 2001
The PLR ceased to be the floor rate for loans above Rs. 2 lakh.
Commercial banks allowed to lend at sub-PLR rate for loans above Rs.2 lakh.
Page 18 of 20
April 2002
A system of collection of additional information from banks on the (a) maximum and minimum
interest rates on advances charged by the banks; and (b) range of interest rates with large
value of business and disseminating through the Reserve Bank’s website was introduced.
April 2003
In place of PLR, RBI announced introduction of a new system called Benchmark Prime
Lending Rate (BPLR). The Reserve Bank advised banks to announce a BPLR with the
approval of their boards. The BPLR was seen as a reference rate and was to be computed
taking into consideration (i) cost of funds; (ii) operational expenses; and (iii) a minimum margin
to cover regulatory requirements of provisioning and capital charge, and profit margin. The
system of tenor-linked PLR discontinued.
ANNEXURE IV
SOME TERMS DEFINED:

Floor Rate : It is the rate below which a bank cannot lend
Reference Rate : It is the rate which is used by banks as a benchmark for arriving
at the lending rate. Usually, lending rates are linked to the
reference rate. LIBOR (London Inter-bank Offered Rate) is
considered a reference rate for a majority of foreign currency
loans available abroad.
PLR : Prime Lending Rate was traditionally the lowest rate charged to
the prime borrowers with highest credit rating
BPLR : The Benchmark Prime Lending Rate was seen as a reference
rate and was to be computed taking into consideration (i) cost of
funds; (ii) operational expenses; and (iii) a minimum margin to
cover regulatory requirements of provisioning and capital charge,
and profit margin.
Policy Rates : Repo & Reverse Repo Rates & Bank Rate are RBI’s policy rates
Reserve Ratios : SLR and CRR are the reserve ratios of RBI
SOURCES:
RBI website
Deepak Mohanty Committee’s Report of the Working Group on study of BPLR
Economic Times, Business Line, Outlook Profit, etc.
DISCLAIMER: The views are personal. The views need not be construed as those of the
organisation which the author represents.
Page 19 of 20
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Base Rate-New System of Loan Pricing by Banks in India-VRK100-13062010

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BASE RATE -

RBI, in April 2009, announced the appointment of a working group to

The Committee’s recommendations have been partially accepted by

This article examines, in a comprehensive manner, the contents of the

Why is RBI switching over to the new Base Rate System

I : Full recommendations of the Deepak Mohanty Committee

1. What is Base Rate?

2. Why is RBI changing the loan pricing system?

3. What are Deepak Mohanty Committee’s Recommendations?

The important recommendations are:

The actual rate charged to borrowers would be Base Rate increased by

At present, the Government administers loans of up to Rs 2 lakh to small

4. Whether RBI has accepted the recommendations?

RBI’s Final Guidelines on Base Rate are as follows:

Base Rate System is to be implemented from July 1, 2010

Banks have to review Base Rate on a quarterly basis

The RBI’s circular on final guidelines is a watered-down version of the Deepak

Deepak Mohanty Committee RBI's Final Guidelines

Base Rate should be applicable to loans No such stipulation by RBI

Educational loans should be administered No such special treatment to Educational

5. How is Base Rate different from BPLR?

6. How is Base Rate calculated?

Banks are free to use any other appropriate methodology, provided it is

7. Will customers be able get loans at Base Rate?

Actual lending rate *

8. What is transparency in loan pricing?

9. What is monetary policy transmission?

Monetary policy transmission is the responsiveness of the banking system to the

1. Loans under the DRI scheme

11. What will be the advantages of Base Rate System?

It is expected that higher transparency will benefit all kinds of borrowers

The Base Rate system is aimed at enhancing transparency in lending rates of

12. What will be the impact of the new method?

Let me try to briefly examine the impact of BRS:

The Base Rate System is expected to usher in a transparent system

13. To what kinds of Banks the Base Rate is applicable?

14. Whether banks have fixed their Base Rates?

15. What is the lending rate for export credit?

16. Why is sub-BPLR rampant in the banking system?

On account of competitive pressures, banks were lending a part of their portfolio

17. What is downward stickiness in rates:

The downward stickiness in BPLRs is also attributed to several other factors

18. What is the criticism of the Base Rate System?

19. CONCLUDING REMARKS

Moreover, it will be interesting to watch the response of the market, banks,

REPORT OF THE WORKING GROUP ON

The Working Group had the following terms of reference:

The Committee’s observations and recommendations:

i. The card interest rate on retail deposits (deposits below Rs

i. Loans pertaining to selective credit control

Mathematically, the Base Rate is calculated as follows as per RBI’s illustration:

a = cost of deposits/funds = CoD

b = Negative carry on CRR and SLR

[ CoD – (SLR x Tr)]

d = Average return on net worth = ------ X ------ x 100

D = Total Deposits = Term deposits + Current a/c deposits + Savings deposits

Dply = Deployable deposits

CRR = Cash Reserve Ratio

SLR = Statutory Liquidity Ratio

Tr = 364-day Treasury Bill rate

Uc = Unallocatable overhead cost

NW = Net worth = Capital + free reserves

Unallocatable Overhead Cost: It is fixed overhead cost consisting of Head Office

Evolution of BPLR in India : A Snapshot