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By Subhadip Sircar

Indian banks will have to switch over to a new loan pricing system from July 1. The Reserve Bank of India says a new rate, called the base rate, must be used to price all lending, including home, auto and business loans. On Wednesday, the countrys largest lender, the State Bank of India offered a hint of what its rate will be and said it will likely officially announce the number on June 15. As other banks ready their new rates, India Real Time offers a primer on how the base rate will work.
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Bank lending rates are set to become more transparent from July 1.

What is the base rate? The base rate, as the name suggests, will be the rate below which banks cannot price any loans, and should include all the elements of lending costs that are common across all types of borrowers. Each bank can have its own base rate depending on the cost of its funds. What are banks using now? Currently, banks use the benchmark prime lending rate, or BPLR, which has been in vogue since 2003. A committee published a report in October 2009looking at the BPLRs evolution and flaws. Why do Indian banks need to use the new system? The BPLR was often set quite high because it also functioned as the ceiling for pricing higher-risk small loans. The system seems to have worked to the benefit of higher-rated corporate firms who got cheaper loans, while overpricing credit for agriculture and smaller

enterprises. Intense competition among banks resulted in nearly 70%-75% of loans being priced below the BPLR. That has hampered the central banks monetary policy transmission process. When the RBI lowers policy rates to stimulate credit demand in the economy, as it has done repeatedly between the fall of 2008 through most of last year, those signals havent been transmitted to the official rates because of the prevalence of sub-BPLR lending. The new system doesnt set the base rate as a cap for loans of 200,000 rupees or less in fact theres now no ceiling for pricing these loans which may make banks more responsive. How will the base rate be calculated? Banks may choose any benchmark to arrive at the base rate for a specific tenor, as long as they are transparent and consistent. Lenders may include the cost of deposits, the opportunity cost for locking bonds and cash to meet reserve requirements, unallocated overhead costs and profit margins. And for different sorts of borrowers, banks can add customer-specific charges to the base rate. Which loans are exempt from the base rate system? Three types of loans will be exempt from the base rate system loans offered under the differential rate of interest scheme where funds are provided at reduced rates to low-income borrowers, loans to banks own employees and loans to bank depositors against their own deposits.

What happens to existing loans? The base rate will be applicable for all new loans from July 1 and for any old loans that come up for renewal after that date. Existing loans may run till their maturity. But if borrowers want to switch to the new system before their existing terms expire, banks can offer them that option on mutually agreeable terms. Banks arent supposed to charge a fee for switching over, though. Where is the base rate likely to settle in percentage terms? The base rate will generally work out to be lower than the BPLR. State-run banks are expected to set their base rates between 8% and 8.5%, according to bankers. The State Bank of India, the countrys largest lender, expects its base rate to be between 7.5%- 8.5%, bank chairman O.P. Bhatt said on Wednesday. Its BPLR is presently 12.25%. How will bank customers know what their banks rates are? The RBI requires banks to review their base rates at least once in a quarter. The banks must also display information on their base rate at all branches and on their websites

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