Professional Documents
Culture Documents
Prof. b.p.mishra.
XIMB, XUB.
Risk-adjusted returns on loans
Floating-rate loans:
increase the rate sensitivity of bank assets, increase
the GAP
reduce potential net interest losses from rising
interest rates
Because most banks operate with negative funding
GAPs through one-year maturities, floating-rate loans
normally reduce a banks interest rate risk.
Given equivalent rates, most borrowers prefer fixed-
rate loans in which the bank assumes all interest rate
risk.
Banks frequently offer two types of inducements to
encourage floating-rate pricing:
1. Floating rates are initially set below fixed rates for
Marginal
Cost of Estimated
Nonfund Bank's
Loan Raising Margin to
Bank Desired
Interest = Loanable + + Compensate +
Operating Profit
Rate Funds to Bank for
Costs Margin
Lend to Default Risk
Borrower
Price Leadership Model
Default
Risk Term Risk
Loan
Base or Premium Premium for
Interest = + +
Prime Rate for Non- Longer
Rate
Prime Term Credit
Borrowers
Below-Prime Market Pricing
Interest Cost
Loan Markup
of Borrowing
Interest = + for Risk
in the Money
Rate and Profit
Market
Customer Profitability Analysis
Credit Services
Cost of funds
Loan administration
Default risk expense
Noncredit services
Credit services
These costs include the interest cost of financing the loan, loan
administration costs, and risk expense associated with potential
default.
Cost of Funds
the cost of funds estimate may be a banks weighted marginal cost of
pooled debt or its weighted marginal cost of capital at the time the loan was
made.
Loan Administration
loan administration expense is the cost of a loans credit analysis and
execution.
Default Risk Expense
the actual risk expense measure equals the historical default percentage
for loans in that risk class times the outstanding loan balance.
Non-credit services
required reserves
Fee income
Prof. b.p.mishra
XIMB,XUB.
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History
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Till 1980s interest rate regulated
Administered rate are different for different activities
Borrowers were charged different rate for the same loan amount
Since 1990s rationalization
Sept 1990- rates rationalized to six slab. Banks free to fix rate beyond
the limit of Rs 2 lakhs
!993- Six slab compressed to 3slabs
1994- complete deregulation of interest rate above Rs 2 lakhs
Introduction of PLR
1997- separate PLR for CC & Loan component
Oct,1997- separate PLR for term loan
1999- tenor linked lending rates introduced
2000- banks are free to charge Fixed & Floating rate.
2001, April- PLR ceased to be the floor rate for loan more than Rs2lakhs
2003- BPLR introduced reflecting the true cost of funds of the banks.
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BASE RATEW..E.F JULY,2010
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Some Facts
Sub PLR Lending (PSU) constitutes 67% of Total
Lending as March 2009.
Sub PLR Lending (Foreign banks) constitutes 81%
of Total Lending as March 2009.
Sub PLR Lending (Pvt. Sec) constitutes 84% of
Total Lending as March 2009.
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RIP.BPLR
There is a structural problem .
BPLR was introduced in 2003 as a move towards interest rate
deregulation in the Banking sector
Even though the industry is by and large deregulated, a few
lending rates are still mandated and linked to banks BPLR
For example, loans to exporters are given at 2.5 percentage
points below BPLR. Similarly, all loans to small farmers are
priced cheaper than BPLR.
This has prevented banks from lowering their BPLR as the
moment this benchmark rate is cut, automatically the loan rate
for exporters and small farmers declines.
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So banks preferred to keep their BPLR at an
artificially high level and charge most of their
borrowers a rate much below the benchmark rate.
This is the only way they could prevent loan rates
for exporters and small farmers from
decliningdownward sticky
In particular, the fixation of BPLR continues to be
more arbitrary than rule-based.
Therefore, the concept of arriving at the BPLR needs
to be looked into with a view to making it more
transparent
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RIP.BPLR
Despite that, most of the banks ended up having
their BPLRs in the same range even though their
cost of funds, overheads and level of non-performing
assets were not alike.
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Why Base Rate.
The BPLR system, introduced in 2003, fell short of its
original objective of bringing transparency to lending rates.
mainly because under the BPLR system, banks could lend below
BPLR.
For the same reason, it was also difficult to assess the
transmission of policy rates of the Reserve Bank to lending
rates of banks.
Hence, the Base Rate system is aimed at enhancing
transparency in lending rates of banks and efficiency in
transmission of monetary policy
The Base Rate system replaced the BPLR system with effect
from July 1, 2010.
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Why Base Rate.
Issues In Transparency
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Downward Stickiness of BPLR
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Components of Base Rate
1. Cost of Deployable Deposits
Total Deposits =
Time deposits + Current Deposits + Savings
Deposits
Deployable Deposits =
Total Deposits less share locked in CRR & SLR Balances
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2.Negative Carry on CRR and SLR
Negative carry on CRR and SLR balances arises
because the return on CRR balances is nil, while the
return on SLR balances (proxied using the 364-day
Treasury Bill rate) is lower than the cost of deposits .
Negative carry cost on SLR and CRR was
arrived at by taking the difference between
Return adjusted Cost of Funds( RACOF)
and the Cost of Deposits.
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3. Unallocated Overhead Cost
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4. Return on Deployable Deposits
=( NP / NW ) X (NW / Deployable
Deposits)
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Components of Base Rate
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http://banks-india.com/banks/bank-base-rates-comparison/
http://thebankingbible.com/iob-andhra-bank-icici-bank-sbt-ubi-
uco-bank-dcb-ing-vyasa-bank-jk-bank-ps-bank-vijaya-bank-united-
bank-corporation-bank-kokatk-mahindra-bank-sbbj-syndicate-bank-
revises-base-rate-and-1567
http://www.corpbank.com/asp/0100text.asp?presentID=1714&hea
dID=733
http://www.sbi.co.in/user.htm
http://www.corpbank.com/asp/0100text.asp?presentID=1715&hea
dID=19
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Applicability of Base Rate
All categories of New Loans should henceforth be
priced only with reference to the Base Rate.
The Base Rate could also serve as the reference
benchmark rate for floating rate loan products.
http://new.axisbank.com/personal/loans/home-
loan/home-loan-fees-charges.aspx
45
However
Three other categories of loans will not need to
adhere to the base rate formula
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Misuse of Base Rate
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International Comparison
In the US, the Prime rate(3.35% in 2011)
normally 3 percentage points higher that the Federal Fund
Rate(0.1%..in 2011)
is the benchmark rate for all consumer and retail loans.
http://www.federalreserve.gov/releases/h15/data.htm
http://www.federalreserve.gov/faqs/credit_12846.htm
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Similarly, in the UK,
the Bank of Englands base rate is the benchmark rate for
consumer and retail loans,
http://www.nytimes.com/interactive/2012/07/10/busine
ss/dealbook/behind-the-libor-scandal.html
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Libors Indian counterpart is Mibor,
or the Mumbai interbank offered
rate
The rate at which banks can borrow funds from
each other in the interbank market.
But this is an overnight rate and the efforts to
develop one-month and three-month Mibor have
not yet met with success.
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MCLR Linked Interest Rate
w.e.f.1st April,2016
Banks are required to Switch to the
Marginal Cost of Funds based lending Rate(MCLR).
It will modify the existing Base rate System.
Banks have to prepare the MCLR s which will be the
internal Bench Mark Lending Rate.
Based on this MCLR, The interest rate for different Categories
of loans to be fixed in accordance with their risk profile.
The MCLR should be revised monthly.
Banks have to set five Benchmark rates from different tenures
from Overnight ( one Day ) to One Year.
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contd
The New method uses the Marginal cost or
the latest cost conditions reflected in the interest rates
of banks to obtain funds( From Deposits &
Borrowing from RBI) while setting the Lending Rates.
52
contd
The MCLR system helps in monetary transmission-
effective passing on a Repo rate change to an interest change
by the Banking System.
Because it is mandatory for banks to consider Repo rate
while calculating MCLR.
Under the Base rate system, Banks changed the Base rate
after a time lag , while under MCLR, the change has
to be made monthly.
Any change in the Repo rate brings a change in the
marginal cost, hence the MCLR Will also be changed.
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Contd
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Contd.
MCLR to be reviewed monthly and publish the MCLR
on a Pre-announced date.
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thanks
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