BASE RATE

What is base rate?

It is the minimum lending rate that banks can charge their customers from July 1, 2010. So far, all lending rates were pegged to a bank’s prime lending rate (PLR). Under the existing system, banks charge customers interest rate either above the PLR or below PLR. Thus PLR worked as an anchor rate. From July 1, the base rate will not only replace the PLR as the benchmark, but it will also be the new floor rate below which no bank can lend. India’s largest bank, the State Bank of India, has indicated that it plans to peg its base rate in the range of 7.5-8%.

What will happen to loans linked to PLR?

Outstanding loans that are linked to PLR will continue to exist alongside the new loans linked to the base rate. As the old loans get repaid or the contract comes up for renewal, the base rate will become the sole benchmark.

From July 1, on all new loans, banks will charge customers at base rate or above base rate, depending on the rating and relationship. As and when the loan contract comes for renewal, banks will link the interest rate to the base rate. Existing customers will also get a choice to migrate to base rate. Customers will not be charged any penalty if they wish to migrate from PLR to base rate before the contract is due for renewal.

Why is base rate being introduced?

It is aimed at bringing more transparency in the lending market. As of now, the prime customer bargain rate is below PLR while average to risky customers are charged at PLR or above PLR. About 70% of the loan given by banks is at rates below PLR. Some banks have lent at 6% when their PLR is 13%. As a result, a customer who is able to bargain the most get the best rate. In case of base rate, no bank will be able to lend below base rate, making lending rates comparable.

What will happen to home loan customers?

Home loans are long-term contracts and thus it does not come up for renewal like most other corporates loans. Therefore, banks may give all existing customers a choice to move to a base rate. There are instances of home loans where the interest rate is fixed for initial years and floating rate in following rates. Here, in subsequent years, interest rate is a few basis points below PLR when it moves to floating rate regime.

In such cases, the base rate will not implicitly replace PLR. If the loan document, for instance, says after three years home loan will be 300 bps below PLR, it would not mean that the loan would be 300 bps below base rate once the base rate regime comes into being. Because, in any way, no loan can be below the base rate.