What is the Base Rate?

Base rate is the minimum rate at which a commercial bank in India is allowed
to offer a loan to a borrower, as per RBI guidelines. This along with the
credit risk premium decides the cost of the loan. All commercial banks in
India have the freedom to decide their respective base rates as per the
duration of the loan, considering rules and regulations framed by the RBI.
While a bank has the autonomy to zero upon a minimum lending rate, no
bank can offer a loan that is lower than this benchmark interest rate i.e., base
rate.

Introduction of the Base Rate

Now that you know the base rate definition, let us see how it came into effect. The
RBI introduced the base rate as the standardized rate of lending for all banks in
India on July 1, 2010. Loans that were approved as well as those up for renewal
after this date could be switched to the new base rate system. However, banks
also had the option to continue with the Benchmark Prime Lending Rate (BPLR)
for loans taken by borrowers before July 1, 2010.

Why was Base Rate Introduced?

Base rate was a measure taken by the RBI for increased transparency, clarity and
removal of disparity in the lending process. The BPLR system that was
operational before the introduction of the base rate had led to non-uniform lending
rates by banks. This is because under the BPLR system banks could fix the rate
of interest in consultation with their boards.
However, there were no restrictions on lending at a rate below the BPLR which
led to inconsistencies in different loan rates. For instance, while low-risk
customers such as corporates were offered loans at a rate below the BPLR,
salaried and other individuals had to pay the usual lending rate. Removal of BPLR
and adherence to base rate definition has brought about a reform in the banking
system by setting a standard for the rate of lending without bias. The benefits
have been directly transferred to you, the borrower who is no longer in the dark
about the interest policy of a bank when you apply for a loan.

Difference between Base Rate and BPLR

BPLR system allowed banks the flexibility to offer varying interest rates to their
customers. The rate at which a bank was interested to lend money to its different
customers was defined as the Benchmark Prime Lending Rate. There was no
standardisation in the process and hence lack of transparency on how a bank
arrived at BPLR for a borrower.
However, the base rate definition establishes it as the threshold interest rate as
mandated by the RBI below which a borrower cannot be provided with a loan.
Clarity in base rate meaning has brought in more objectivity to the lending
process by standardizing the lending rate across all authorized financial
institutions. This has helped to do away with favouritism during loan approval
process with individuals from all financial backgrounds having access to a fixed
and transparent interest rate when applying for a loan.

Base Rate Calculation

Each bank has a unique base rate that it arrives at in line with the RBI
regulations. Computation is done based on lending rate factors that are common
to all lender categories such as:
 Fund cost or rate of interest of the deposit
 Minimum profit rate
 Operating expenses
 CRR (Cash reserve Ratio) cost
Among all the above, the cost of deposits holds the most value in the base rate
calculation and a bank may take a call on which loan’s cost of deposit it would
want to consider to compute the base rate.

Base Rate Modification

Since April 1, 2016, all Indian banks have started following the Marginal Cost of
Funds based lending system which uses the MCLR method to calculate the base
rate. This method is more dynamic since banks are required to update MCLR
every month. Here are a few components used in the calculation of MCLR:
 Cost of operation
 Tenor premium
 Marginal cost of funds
 Negative CRR carry on amount
This methodology makes use of the marginal cost to compute the cost of the
funds. The marginal cost is in turn calculated by using the bank repo rate and
other additional costs involved in fund acquisition.