The Reserve Bank of India on Friday gave freedom to banks in deciding their base rate. "Banks may choose any benchmark to arrive at the base rate for a specific tenor that may be disclosed transparently," RBI said, as it released the final guidelines this evening.
The system of base rates, which is to kick in on July 1, will be the new benchmark to arrive at lending rates.
In the draft circular, which was based on a working group report, RBI had said the base rate would be linked to the cost of deposits, a negative carry for statutory liquidity ratio and cash reserve ratio, overhead costs and a profit margin. But now, the formula has been turned into an illustrative example.
The only thing that has survived from the working group stage to the final guidelines is the bar on lending below the new benchmark. Even here, there is a concession for banks to lend to employees below the base rate. Also, those who borrow against deposits and small-ticket borrowers under the differential interest rate scheme would be exempted.
Besides, the regulator has withdrawn the stipulation of benchmark prime lending as the ceiling rate for loans up to Rs 2 lakh. As a result, banks will have to link farm loans to the base rate, bankers said. Subsidised agricultural credit can be provided if there is budgetary support from the government, a banker added.
In last year's annual policy statement, RBI had proposed to replace the existing system of benchmark prime lending rates to make risk pricing more transparent. At present, nearly three-fourths of the bank lending takes place below the BPLR.
"It is expected that the above deregulation of lending rate will increase the credit flow to small borrowers at reasonable rate and direct bank finance will provide effective competition to other forms of high cost credit," RBI said.
Bankers had lobbied hard with the regulator to seek concessions such as those given to employees and also sought an extension. While RBI had decided to defer the implementation to July, from April proposed earlier, today, the regulator allowed banks additional flexibility. It permitted them to change the methodology till December.
RBI has asked banks to review the rates every quarter and ensure that transparency is maintained.
A senior public sector bank executive said that the move would curtail competition. "While some variation in base rate of banks may be seen in the first six months, most banks will converge to a similar band from January," the executive said.
Besides, bankers said that with emphasis on Basel II norms, risk-based pricing and the tenure of loans would play crucial role in determining effective rate charged to customer.
Another bank executive said that banks, which have been lending at a heavy discount to the benchmark prime-lending rate, would face limitations in the short-term market. "This segment would see competition from non-banking finance entities and mutual funds. Perhaps, this could help to improve margins for banks in the long-run," the executive added.