RBI wakes up Finally!!

Before 2001 the bank lending rates had a fixed floor price – Prime Lending Rate (PLR) – below which the banks could not give a loan. The Prime Lending Rate is the rate at which the bank’s best customer is provided a loan. Lending followed a simple rule: Lower the creditworthiness of the customer; the more would be the bank’s lending rate. 

It was in early 2001 that the chairman of Bank of Baroda had mooted the idea of sub-prime lending rate (PLR) lending. After a lot of lobbying by the banks over the issue, RBI finally relented and the banks were allowed to lend out loans at a rate below their prime lending rate (PLR) for which the amount exceeded Rs. 2 Lacs. This method of lending below the prime lending rate was supposed to facilitate exporters and creditworthy business enterprises to avail loans on a transparent basis, approved by the board of the bank. 

Nine years later, today, the RBI feels that the Prime Lending Rates have lost their transparency. The reason that the RBI has realised this now is the Recession. While in the recession the government tried to stimulate the economy through fiscal policies such as lowering of interest rates, lowering of the cash reserve ratio (CRR). A commensurate trickle down in the prime lending rates (PLRs) was not observed. The major factor for this was the sub-PLR lending. 

Initially before sub-PLR lending was allowed, the banks had to park their excess deposits with RBI in case they did not find suitable creditworthy people. But the scenario was vastly different in the post sub-PLR lending era. Whenever the banks were faced with excess liquidity or under the duress of meeting the lending targets or maintaining the client relationships, loans were granted at very low interest rates. As sub-PLR gained popularity, even people started bargaining with two branches of the same bank to avail loans at lower interest rates. The banks also argued that as long as they lent out the funds at an interest rate higher than the RBI reverse repo rate, they were in fact avoiding a greater loss. In their effort to bag more debtors and meet their lending targets, little did they realize that the depositors would have to be paid a higher interest than the RBI reverse repo rate. So, slowly over time, the PLR had turned into MLR - maximum lending rate. So, whoever possessed a higher bargaining power could manage to get a loan sanctioned at a lower interest rate. 

These were the fundamental reasons for the RBI to revamp the bank loan segment with the introduction of base rate. This base rate is supposed to evaluate the minimum rate at which a bank should lend so as to be able to cover up the overall costs. Banks are not allowed to lend at a rate below the base rate. Thus the now the customer would be aware of the lowest rate being offered to the best customer. This will definitely lead to more transparency. 

But this system will hold tight only as long as there are firm guidelines standardizing the calculation of the base rate. Some experts believe that the factors in consideration for the calculation of base rate are potential loopholes. To arrive at the base rate the banks have to take into account the cost of deposits and the profit margins. If standardized regulations are not laid out for consideration of the amount towards these items, the banks would have found a flaw to reduce their base rate to a sufficiently low level and the system still would not be transparent.