Base Rate system and it’s effect on lending rates

The banks have moved to a new base rate system. This is to make the lending rate more transparent. Also, the changes in lending rates are passed on to the client.

Erstwhile Prime Lending Rate ( PLR) had been opaque and much of the lending were happening below this rate, in any case. Also, the changes in rates initiated by RBI were not being transmitted, which was a key concern for RBI, in it’s efforts to manage money supply.

In the new base rate system, the base rate is fixed by the banks and is common for all category of borrowers.  Lending below this rate will not be possible. The interest charged to clients would be base rate plus a premium, which is specific to the borrower, their credit risk, tenure etc.

One major advantage of this system is that when the rates go down, the interest rates would reduce by that same percentage… this was not the case earlier. Interest rates, when it goes up, is increased almost immediately by the banks and they take their own time to adjust it, when it comes down.

But will this change itself benefit any category ?

I doubt it. Even in the previous scenario, interest rate charges  were in line with the perception of the bank about the client – in terms of risk perception/ credit worthiness, tenure, specific nature of loan advanced etc.

Will lower base rate in a bank be more advantageous?

As the banks are lending on a base rate plus a premium basis, their perception of the risk and return is what matters, So the final interest is not going to come down, if their perception regarding a particular client is unchanged.

What about industry ?

For industry too, there is going to be no real change, unless they can demonstrate on a case by case basis that they merit a lower rate due to various positive factors. The factors maybe obvious ones – better profitability, prompt  servicing of existing loans,  strength of the balance sheet etc. The less obvious ones which can be used to advantage would be newer line of products/ markets, lower sundry debtors, better quality / specialist manpower induction into the company, better realization on existing products, cost control initiatives, investment by respected entities/ persons etc. Ultimately, the borrower has to create a feeling of comfort in the lender that they indeed belong to a lower category of risk. That is the only way to reduce in the new regime too.