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What is base rate

From July 1, banks will move to a new, more transparent regime of
loan pricing .they will jettison the Benchmark Prime Lending Rate
(BPLR) and price loan off a “base rate”

Unlike the BPLR that was set somewhat arbitrarily by bank, the base
rate will follow an explicit formula that factors in a bank's cost of
deposits, operating cost (expenses of running its brunch, for
instance), the cost of statutory drafts on bank funds imposed by
Reserve Bank of India( the CRR and SLR) 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.
Cont …
RBI has stipulated that banks cannot charge below the base rate for
most loans. (There are a couple of exceptions like agriculture loan
and export credit.) While the new model will ensure greater
transparency, it need not mean lower lending rate for borrowers.

In fact banks’ blue chip corporate could see some increase in their
cost of borrowing. The reason is somewhat simple. RBI allowed
banks to lend below their prime lending rate and the majority of
banks did the bulk of corporate lending at ‘sub-PLR Rates’.

the new reference rate for country’s largest bank is 9.5% most of the
other public sector banks have the base rate at 8%. This include
IDBI Bank 11.75%
Cont …
The best ‘credits’ for a bank could drive the hardest bargains. This
led to peculiar situation in which a bank whose official BPLR was in
the range of 14-16% was found lending its customers way below 5-

The incentive for the ‘irrational’ pricing was to keep the ratio of non-
performing assets low, particularly in the wake of the Global financial
crisis and banks’ risk appetite waned and safety got precedence
over margins. The rate regime does away with this.

Floating rate home loans borrowers, stuck on higher interest rate,

can expect some relief from today ( July 1)

The introduction of base rate will ensure that if they are linked to it,
they will see automatic rise and fall in their existing rates.
Cont …
The RBI have asked banks not to change any fee for shifting the
prime lending rate to base rate. Importantly, even though banks are
going to change a fee- in excess of 1.5% in most cases – for
renegotiating the loan, it could still make sense in doing so.

Once you have shifted to the latest rate, this along with the linkage
with bank rate will ensure that future costs are saved.

The PLR regime was sticker. Banks took a longer time to align PLR
with the interest rate movements, “KVS Manian, head, retail
banking, Kotak Mahindra Bank.

However only home loan rates will be impacted by this. All other
retail loans, like auto and personal, are given at fixed interest rate
Cont …
But not all home loan customer would benefit linking their loans to
the new benchmarking system. For example if you can take a
teaser loan just few mounts back, it would still make sense to stick
to it.

And with SBI planning to continue its teaser rate of 8% for the next
few months, borrowers would continue to benefit.

“in Dual rate (or teaser) the loans, a borrower gets a fixed rate for
the initial years. This means there is predictability of monthly outgo
for this period and the borrower, in turn can plan the finance
accordingly without bothering about interest rate fluctuation,” said a
certified financial planner.
Cont …
For an existing borrower, there are some situations in which they will
benefit by shifting. In other cases, it may not make much difference.

Less than one year: if you have taken the loan just a year back,
around 90% of the equated monthly instalment (EMI)goes towards
repayment of interest and the rest towards principle.

If serving a floating rate loan for less than two years, financial
planners said it makes sense shifting the loans – even if the lender
is charging you a interest of 9-9.25%
Cont …
When a person shifts to base rate, the interest is likely to remain the
same. In addition, shifting is free. Shifting early to a new benchmark
would only help to get the benefits earlier. And if the existing loan
rate is around 1-2% lower than your existing rate, it makes sense to
renegotiate as well.

Of course, there will be charge. But you can easily get into a new
regime which is completely new and more sensitive to change.

2 to 5 years : there is a strong possibility that such borrowers are

stuck at higher floating rates of 12-13 %. It certainly makes sense for
them to shift from their existing rates to new one. And by paying
renegotiating charges as well.
Cont …
Over customers should shift to the base rate as even in the fifth
year, the interest portion is as over 40% if the tenure is 15 years and
more for loans with longer tenure.

There are customers who fixed their rate at 7.8-8% in 2003-04

period, it makes less sense for them to shift, especially if their loan
rate is fixed for the entire tenure.

5 to 10 years : This is a crucial period to decide whether to shift or

not. For 15- year loan, two-third of the loan is repaid. For 20- year
loan, the interest portion in the tenth year is still more than principal.
Cont …
“There are changes that a person has brought the further down by
prepaying a portion of the loan as and when possible.” said a
certified financial planner. A person can stick to the BPLR who has
15- year tenure. For loans over 15 years, base rate would make
sense as there are still many years left to service the loan.

Over 10 years: if your loan tenure is of 20 years, almost 50% of the

time period is remaining. But the good part is that most of the
interest payout has taken place.

During these years, the principle portion in the EMI account 60% or
more, as you get closer to repaying the loan. Shifting to base rate is
a tough call in such a sitution.
Cont …
Do your math and compare the advantages of BPLR vis-à-vis base
rate. If you have more than three years to repay the loan and you
still saving money on the EMI, go for it.

What you must do: shift to the base rate anyway. Because it will
ensure that you get advantage of loan rate fluctuations.

As far as renegotiations go, it would be a decision based on the

tenure that is remaining, and your finances.