Pricing of Loans against the Base Rate Norms

What is the Base Rate ? It is the minimum rate of interest that a bank is allowed to charge from its customers. Unless mandated by the government, RBI rule stipulates that no bank can offer loans at a lower rate than BR to any of its customers. Difference between Base Rate and BPLR BPLR is the Benchmark Prime Lending Rate and is the rate at which banks in the country lend money to their most credit worthy customers. Till now, RBI had given a free run to the banks to fix their BPLR and different banks do have different BPLR causing resentment among customers. Add to it the practice of banks to provide loans at a much higher rate than their BPLR and it completes the misery of the common people. Keeping all this in mind, RBI has suggested the use of a Base Rate in place of BPLR The current system of applying BPLR linked rates to loans and advances is in force since 2003. It was intended to bring transparency to lending rates. However, over the years the bank started to lend much below the BPLR because of various reasons. Due to this RBI setup a committee under the chairman of Shri Deepak Mohanty to suggest an alternate system. Based on the recommendations of the committee RBI advised the banks to switch over to the system of Base Rate w.e.f 1 July, 2010. As per the bank visit , Bank of Baroda provided me with the following norms of the RBI, which the banks follow for deciding their base rate.( The following information was provided by Mr. H Shivkumar, Corporate Financial Services Branch) As the very name suggests banks are prohibited from lending at rates below their declared base rate under any circumstances except in case of: Short term agricultural loans. Export credit where the interest concessions granted by GOI Loans granted to a corporate post restructuring. DRI scheme Advances against banks own deposits. Loans granted to banks own employees

The components included for calculating base rate includes : Cost of depostis/funds Negative carry on CRR and SLR reserves Unallocatable overhead cost

Average return on net worth

At the same time the banks have been given the freedom to choose any other methodology for calculating the base rate which is transparent and disclosed publicly. During the first six months i.e. before 31-12-2010, banks have the freedom to the change the methodology. Once decided this rate is to be reviewed atleast at quarterly intervals. Other guidelines related to base rate includes: The ceiling rates for loans upto Rs. 2lacs I withdrawn All the existing loans / facilities based on the BPLr system may run with the existing interest rate structure till their maturity/ review Existing borrowers have the option to switch to base rate system before maturity / review No fee for such switch over All the existing A/cs falling due to review on or after 1st July 2010 would be priced with reference to Base rate at the time of their review Fixed interest rate option on all the Retail Loan products stands withdrawn Henceforth no loan shall be granted at fixed rate option Existing facilities under fixed rate option shall continue till their reset clause / maturity whichever is earlier The stipulation of minimum interest clause on all retail loans shall continue.

Over the base rate the bank adds the floating rate which is the spread, the floating rate is decided by taking different factors into consideration, The bank uses CRISIL software to rate these factors and based on the ratings (for eg. BOB1,BOB2), interest rates are decided. Higher the risk , higher the interest rate. As told by the Senior Manager of Bank of Baroda, company rated BOB6 are judged to offer moderate safety of timely payment of interest and principal for the present , there is only a marginal difference in the degree of safety provided by issues rated BOB 5, as the ratings decline the risk increases. Different types of risk are rated on this software like Environment Risk, Business Risk, Completion Risk, Execution Risk, Credit Risk etc.