The creation of committees and reports is a hallmark of all bureaucracies. The RBI has just brought out for discussion another report on the benchmark prime lending rate to make it more relevant for users. We have had indicative rates for some time now which never really served the purpose but were still used since there was no alternative. The minimum lending rate (MLR) in the early reforms period prior to 1994-95 was probably the closest benchmark.
The basic issue which the RBI has with the BPLR is that there are several loans that are disbursed at a rate which is below the PLR. This makes the rate opaque. These sub-PLR loans are given to the ?super customers? who can actually access the Euro market or raise funds domestically at lower rates as the risk involved is minimal. Hence, while the PLR is supposed to apply to the best customers, there are still customers who are better than the best. This makes the concept of PLR quite irrelevant.
In fact, curiously, the average return on advances for a large number of banks is well below their announced benchmark PLR.
But why do we need a PLR? The idea was to have a reference rate that would add a modicum of transparency once the premium band was also announced. This is why the sub-PLR rate could not be renamed as the PLR as this would mean that the banks could not go beyond the band. The solution would, of course, be to increase the band in case the risk factor was high. However, if the band was say 600 bps, then the structure would become opaque as it would become too high. However, there were still exceptions to the rule in the case of consumer loans or credit cards. The end result was that it has created considerable confusion in the minds of all borrowers.
The Committee has spoken of the announcement of a base rate, BR, which would be calculated based on actual costs and return-on-capital. This should have been the formula for reckoning the PLR to begin with in case the banks were to ensure that every loan covered the cost of the funds that were being deployed. Briefly, the zero risk loans would involve the following considerations: cost of funds, operating costs, return-on-capital, provision for NPAs, opportunity cost of funds, cost of CRR and SLR.
Two issues arise here. The first is whether in banking, banks need to have a fixed rate for all, like we have for a finished good. It could be a good strategy to give loans to certain parties below the base rate and make good the same through higher rates to others as the borrower is superior, or there is a larger banking relation. This also makes sense if a bank is strong on non-fund based fee income where further cross-subsidisation takes place. Besides, the RBI has fixed norms for export finance to the PLR. Therefore, if the PLR is lowered, then there will be a loss on these special loans.
However, the Committee still talks of permitting up to 15% of incremental credit at sub-base rate. The RBI on its part should not add to the ambiguity by allowing such lending because if this was okay, the same could have been allowed with the PLR and a Committee was not needed to deliver the same result. Further, there is no sanctity to the 15% level. Either we allow sub-base or sub-PLRs lending or simply ban the same. By blowing hot and cold on the issue, the RBI is actually not sure of its own stance.
The second issue is broader. Should the RBI be involved with the pricing of loans by banks? In a free system, which is what we purport to be, banks should have the right to price their products and the
RBI should not be advising them on the same. There is, of course, a conflict here between freedom and transparency. However, if we ideologically agree to free pricing then banks should be asked to reveal their lower and upper ranges for various loans without fixing a band so that customers are aware of the same.
Our banking system continues to be heavily regulated by the RBI. Priority sector lending is the most evident manifestation of this regulation. Further, rates are specified for all banks on various kinds of credit such as exports, DRI, education, etc. In a deregulated set up such restrictions are not desirable and banks should have the freedom to charge rates that make commercial sense. By linking such credit to the PLR, the RBI was actually forcing the banks to maintain relatively higher PLRs or BRs. By removing such conditions, the market mechanism would lead to an optimal equilibrium.
?The author is chief economist, NCDEX Ltd. These are his personal views