From April onwards, banks will price their loans based on a base rate rather than a benchmark prime lending rate (BPLR) as they have been doing so far.
But nothing will really change unless banks are able to assess correctly the appropriate risk that a customer attracts and are serious about charging them for it. After all, even in the earlier system, banks were free to bill clients whatever spread they felt was correct based on the credit risk perception of the customer.
If in some instances they were not doing so and were instead choosing to lend below the BPLR, it was because they were trying to beat the competition in a fiercely competitive environment where money was abundant and credit offtake sluggish. So, instead of parking their large surpluses with Reserve Bank of India (RBI) in reverse repo and earning 3.25%, it was better to make, say 7%, lending to a triple-A customer, even if 7% was way below the BPLR of perhaps 11%.
There will, however, be one difference. On earlier occasions when interest rates in the system have trended downwards, some banks have left the BPLR unchanged but reworked the contracts for premium customers, revising the rates downwards. However, very often they retained the rates for SME customers, thereby increasing their own spreads.
One can?t really blame them or say they were not justified in doing so. Typically, interest rates are low when the economy is not doing so well, and so banks were well within their rights to hold the interest rate for a customer if they perceived the risk to be higher.
After all, they are in the best position to assess the credit risk. However, probably not all banks came clean with their customers on why they were not bringing down the rate.
So, RBI has a point in saying that banks need to be more transparent with customers.
Information on the base rate will need to be put up on the Web sites and at the branches, and banks also need to disclose the maximum and minimum rates for the major categories of borrowers.
Banks needn?t be defensive about this; while it is a tough market and business isn?t easy to come by, it won?t really hurt if they explain to customers why exactly they are or are not revising rates in tandem with any interest rate movements in the system. The BPLR didn?t allow for much transparency and had probably become a bit of a joke; the proposed base rate should be somewhat more sacrosanct in the sense that banks will not be able to lend below this rate. RBI says banks must compute the base rate after taking into account their various costs, which means they may want to take a hard look at all their expenses and try bringing them down.
At the end of the day it?s a competitive market, especially when it comes to lending to top-tier clients, so regardless of the costs of individual banks, the various base rates would have to converge at some level. Only perhaps in an oligopoly can the base rates be very different; in a competitive market, at least AAA clients will all be borrowing at near the base rate, so unless banks want to lose out on that business, they can?t be charging a rate that?s way above what others are.
One reason why banks have tended to keep the BPLR at artificially high rates is that all small loans (up to Rs 2 lakh for agriculture and small industries) and export loans are capped at the BPLR. If the BPLR is revised downwards, it means that the smaller loans need to be repriced, too, something that banks are reluctant to do. That will change now and banks will be free to lend at whatever rates they feel suitable, of course, above the base rate.
There could be a business opportunity here because small borrowers today end up borrowing at very high rates from intermediaries; some microfinance institutions, for instance, reportedly earn a return of over 20% on their investments. If RBI is hoping that the base rate will always move in line with any changes that it might effect in the repo rate, it might be disappointed. After all, interest rates will depend on the demand and supply of money in the system. RBI hasn?t, however, indicated anywhere that it believes this would happen.
shobhana.subramanian@expressindia.com