BASE RATE SYSTEM AND

EFFECTS OF CHANGE IN INTEREST RATE
By: Azharuddin Mansiya

AGENDA What is base rate and why the move Effect analysis of base rate system Base rate calculation Changing interest rates and risk premium Short term impact on corporate borrowings Overall change in investment activity .

low-risk customer . 2010. However all existing loans continue to be at current rate.BASE RATE It is the minimum rate of interest that a bank is allowed to charge from its customers. BPLR is the rate at which a bank is willing to lend to its most trustworthy. BR came into effect from July 1.

75% to 14.25% in Sep·08 to 12.INTEREST RATE INSENSITIVE BPLR ‡BPLRs of public sector banks have moved from a high of 14.25% in Mar·10 and the BPLRs for private sector banks moved from 15.75%. ‡This is despite the fact that the deposit rates for Public sector banks and private banks also declined by 288bps and 200bps respectively during the same period Source: CARE . ‡The quantum of movement in BPLR does not mirror the changes in policy rates leading to poor transmission of policy rates the BPLR of Public sector banks changed by 200bps while for their private counterparts BPLR changed only by around 100bps.

EFFECT ANALYSIS OF BR Transparency Transmission of policy rates Impact on Small borrowers Rise in short term borrowing cost .

COMPONENTS OF BASE RATE a) Cost of deposits b) Negative carry on CRR ad SLR c) Unallocatable Overheads cost d) Returns on Net worth Final lending rate for customers will be the base rate. plus the risk-cost attached to the credit rating perception of the borrower by the bank .

BASE RATE CALCULATION .

14% .79% -0.AN EXAMPLE OF BR Base Rate Cost of deposits/funds Negative carry on CRR/SLR Unallocated Overheads Average return on Networth 7.75% 1.75% 3.90% 0.

When interest rates move up. equities as an asset class tend to underperform and vice versa. which is the function of risk free rate and risk averseness of the investors Source: RBI and NSE .INTEREST RATE AND RISK PREMIUM Essentially. interest is the price the borrower pays and a return the lender earns on his funds. This is essentially due to risk premium. Interest rates have an indirect effect on equities.

HIGH AND LOW INTEREST RATE ENVIRONMENT Source: Reserve bank of India and NSE India Source: Reserve bank of India and NSE India .

Source: Reserve Bank of India . ‡However there are few expenses which companies have to fund on continuing basis irrespective of levels of interest rates.CORPORATE BORROWINGS ‡Companies borrow mainly to fund their long-term expansion plan and for their annual capital expenditure. ‡Hence some amount of borrowing will always be made to fund continuing operations like working capital requirements.

investors prefer to trade and invest in fixed income money market instruments over equity stock markets and vice versa Source: Reserve Bank of India and SEBI . it is safe to say that when interest rates are high. ‡Looking at the data. Investors and market participants are well aware of this correlation.INVESTMENT ACTIVITY ‡Equities as an asset class tend to underperform when interest rates increase.

Thank You .

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