If you are happened to read the recent newspapers, it is most likely to read a news talking about the base rate system for the banks. Every banks announcing the base rates for lending loans. What is that?. I have written earlier in March 2010, about the implementation of the base rate system from 1st July, 2010. In this article, I will explain the use of base rates and how it will impact the banks and borrowers. It is one of the reforms on banking system by RBI to reduce the lending risk for banks. In the next sections, we will see that in detail. If you like the article, Please subscribe to our future articles here.
Say Bye to Prime Lending Rate (PLR)
Before setting the base rate system, banks used another rate system called Prime Lending Rate (PLR) to set their lending rates. The problem with this system is, banks manipulated this PLR to lower level to offer discounted lending rates for the borrowers. It may cause the loss for the banks if they offer loan with much cheaper price. The real intention of the RBI is to make the banking system much stronger after the global financial crisis.
The banks meet huge loss because of the default loans. The main reason is, when banks offer loans with cheaper price to lure the customers, most of the customers without adequate financial support too get the loans. It will end in default (can not repay the loans). Base rate system provides more transparency on setting the rates. Each bank use some criteria to set their base rates.
What is Base Rate System?
As I have mentioned in the previous section, Base Rate System is for the banks to set a level of minimum interest rates charged while giving out the loans. This Base Rate System has many advantages over the older method of Prime Lending Rate (PLR). One advantage is, in the Prime Lending Rate (PLR), one could sanction the loan for lower price for the preferred customer or the corporate bodies and retail customers may have to pay more for the same type of loans. In the base rate system, there will not be much variance on the loans.
However, the base rate system will not be applicable for the following type of loans:
- Agricultural Loans
- Loans given to own employees
- Loans against deposit
- Export Credit
Base rate system is arrived at taking into the account, the cost of deposits and cost of keeping aside cash to meet CLR and SLR. It is convenient for the banks to adjust the lending rates after the changes on policy rates by the RBI.
Transparency on Base Rate System
Another advantage of base rate system is transparency on calculation method to arrive the base rates. Every bank has to declare to the public how they have calculated the base rates. Fro example, SBI has calculated the base rate by taking into account of past six month deposits.
Excerpt from RBI’s Circular on Base Rate System:
Base Rate shall include all those elements of the lending rates that are common across all categories of borrowers. While each bank may decide its own Base Rate, some of the criteria that could go into the determination of the Base Rate are: (i) cost of deposits; (ii) adjustment for the negative carry in respect of CRR and SLR; (iii) unallocatable overhead cost for banks such as aggregate employee compensation relating to administrative functions in corporate office, directors’ and auditors’ fees, legal and premises expenses, depreciation, cost of printing and stationery, expenses incurred on communication and advertising, IT spending, and cost incurred towards deposit insurance;and (iv) profit margin.
Base Rates for Banks
The following table presents the base rates announced for some of the leading banks.
Summary
I hope this article would be useful to know the purpose of bringing the new rate system into the banks. It is end of PLR and beginning of new rate system. We have to wait and watch, how the banks set their rates when there is any change in the policy rates. Keep update on the banking news by subscribing to our free newsletter.
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October 2, 2010 at 7:22 am
this article on base rate is very good it just cleared itself fundamentally…nice one
October 21, 2010 at 1:26 am
this article is like having a lecture frm an expert…it is easy in language as well as cleared all doubts about base rate……..
December 30, 2010 at 11:45 pm
only one wod excellent
January 12, 2011 at 12:02 pm
excellent…..whole concept of base rates is clear…thanks 4 telling it 2 everybody…
January 26, 2011 at 7:11 am
really my doubt has been cleared.
February 3, 2011 at 4:11 am
it has supplied a very fruitful information on base rate. very comprehensive and easy to understand. very nice explanation
February 8, 2011 at 1:51 am
very clearly defined….not required to understand the deep banking system to understand the topic.
February 14, 2011 at 3:35 am
Great way of explanation…keep updating us!
February 20, 2011 at 8:19 pm
Really base rate is very transparent system of taking interest.all bank should apply it as early as possible.
March 29, 2011 at 6:45 am
very comprehensive and easy to understand. very nice explanation
March 30, 2011 at 10:07 am
very easily understandible…thank u
April 19, 2011 at 7:22 pm
I read it like a story…just once, and smiled. Thanks a’lot for clearing my concept. Best part of the article is its language,so simple and so informative. Thanks
May 11, 2011 at 1:14 am
exceleent… bravo!!!
May 13, 2011 at 9:14 pm
Information is adequate for understanding and is given in simple language.
June 9, 2011 at 3:31 am
excellent this article is really very useful for knowledge abt rate
June 11, 2011 at 10:41 pm
Really very helpful thnx alot……………..
July 15, 2011 at 6:10 am
Really its a very good explanation.
July 24, 2011 at 9:48 pm
this is the first time i m able to understand base rate so easily…. u did a great job
July 31, 2011 at 1:01 am
Excellent explanation. Thanks. Keep it up.
August 1, 2011 at 11:36 pm
complete and easy explaination, Thanks
August 3, 2011 at 11:11 am
cool…. so easy to understand… thankss bro……
September 25, 2011 at 12:59 am
great article for it’s lucidity
September 25, 2011 at 2:17 am
Thank you for the comments.
- krishna
October 9, 2011 at 5:13 am
What is base rate.Please explain in detail.
November 16, 2011 at 11:14 am
I donot understand,the meaning of base rate.please explain it
December 9, 2011 at 2:58 am
this very best for india
March 3, 2012 at 4:26 am
it was easy to understand base rate. thanx for the article
March 15, 2012 at 8:38 am
All the Text available on this page is very easy and
well written. which are easy to understand in first see.
it’s really good……..
March 15, 2012 at 8:39 am
All the Text available on this page is very easy and
well written. which are easy to understand in first see.
good text…..
April 15, 2012 at 8:20 pm
explation simple to under stand for person like me
June 25, 2012 at 11:58 pm
very very nice …………..i like very much
June 26, 2012 at 6:30 am
Thank you so much!!!
September 16, 2012 at 8:25 am
Nice explanation which is easy.
January 29, 2013 at 5:07 pm
brother really fantastic language. thank u.
May 11, 2013 at 3:03 pm
hiiiiiii
I have a small doubt
who sets the base rate?
it set up by RBI or not..
Please publish the answer