Base Rate in Banks

THE Indian banking industry is stepping into an age of probable transparency in lending to customers with the new base rate regime, as the Reserve Bank of India (RBI) corrects its past mistake and in the process raises the prospect of a more effective monetary policy.
Nearly 80 banks, ranging from the nation’s biggest—State Bank of India—to the only locally-listed foreign bank—Standard Chartered—will now stop lending below 7%, even if it is to a blue chip, some of which were paying lower than funding costs. The base rates range between 7% and 8.75%, and can differ among banks since costs vary.
The base rate—the floor below which a bank cannot lend even to its top-most client—is arrived after factoring in a bank’s cost of funds and other operating expenses. It is effective Thursday and replaces the muchabused benchmark prime lending rate (PLR).
“The base rate will be transparent,’’ said SBI chairman OP Bhatt. ``Credit will henceforth revolve around the base rate as it will be the reference rate over which all loans will be priced and it will succeed in monetary transmission.”
A central bank panel in October last had recommended the new system after finding that banks, mostly private sector ones, were not passing on the reduction in policy rates to customers while they were quick to act whenever rates climbed. That blunted monetary policy actions. The lack of transparency in lending also led to accusations that small companies and retail customers were subsiding the so-called triple A customers.
`Prime lending rates continued to be rigid and inflexible in relation to the overall direction of interest rates in the economy,’’ the panel had said. An issue often raised is ``the asymmetric downward stickiness of BPLRs. This not only raises an issue of equity, but also result in poor transmission of monetary policy in credit markets’’.
The main reason for the lack of transparency and cross-subsidising by banks can be traced back to the central bank’s decision in 2001 to allow banks to lend below benchmark rates. That was after banks represented they need a provision to lend below the prime rates since it was an international practice. With many international practices now discarded after the credit crisis, the sub-PLR rate too goes.
After SBI, with a fifth of the market share, fixed its base rate at 7.5% on Tuesday, HDFC Bank on Wednesday set it at 7.25%, and Axis Bank and ICICI Bank at 7.5%. Most staterun banks have set it at 8% while Corporation Bank’s is at 7.75%.
The base rates of Thrissur-based Dhanalaxmi Bank at 7% and Mangaloreheadquartered Karnataka Bank at 8.75% are at the two ends of the range.
Although customers are expected to benefit from the new regime, they may not move in hordes seeking lower rates as many factors such as customer service, branch proximity and comfort levels play a significant role in choosing a bank.
A NEW BEGINNING
BASE FACTORS
The base rate factors in a bank’s cost of funds, profit margin and administrative costs. Risk premium is charged over and above the base rate.
BASE CAUSE
The failure of the PLR system to transmit monetary policy changes forced the central bank to introduce the base rate. This was particularly evident in home loans, where existing customers failed to benefit from a fall in rates.
BASE EFFECT
Top corporates, who currently get the best rates, may bargain for loans at the base rate, or closer to it. But for short-term loans, they will have to tap the commercial paper route or the bond market. For most banks, the migration is unlikely to impact their net interest margin — the difference between the interest earned on deposits and cost of deposits. RATE CARD BASE RATES FIXED BY LEADING BANKS
7% Dhanlaxmi Bank, DBS Bank India 7.25% HDFC Bank 7.5% SBI, Axis Bank 7.75% Corporation Bank, State Bank of Mysore, Federal Bank 8% BoB, OBC, Allahabad Bank, BoI, Indian Bank, IDBI Bank, UCO Bank, PNB 8.25% Syndicate Bank, Dena Bank, IOB 8.5% Karur Vysya Bank 8.75% Karnataka Bank 11-13.75% Range of existing benchmark prime lending rate that will end today Customer loyalty may be tested
MANY of these players have been banking with us for a long time and are loyal to us,’’ said KSR Anjaneyulu, MD & CEO of Lakshmi Vilas Bank, referring to small companies and traders. “This segment of customers is unlikely to be impacted significantly by a 0.25-0.5% rise in interest rates.”
But that claim of customer loyalty may be tested in the next few months as SBI looks set to lure customers with teaser rates even as rivals who pioneered them are bidding adieu to the scheme. It has extended the special home loan scheme for three more months till September 30 while HDFC and ICICI Bank have ended it.
The SBI scheme offers a fixed rate of 8% in the first year and 9% in the second and third years irrespective of the loan amount. It floats from the fourth year with market rates. SBI’s home loan portfolio grew 31.5% last year to Rs 73,400 crore. “We are not looking at increasing market share at the cost of our profitability,” the bank’s chairman said.
Investors believe that migration to the base rate may not impact the profitability of banks since they are factoring in the costs. “There would be no change in the net interest margins,’’ said Vaibhav Agrawal, VP-research, banking, Angel Broking. ``We are not re-rating the banking stocks under our watch.”
There is room till December to tweak, if the formula does not work.
`We do not know how the base rate will play out,’’ said Mr Bhatt. `RBI has enabled us to change it once. If there is anything wrong with the methodology, it can be corrected.”