Base Rate
The base rate, introduced with effect from 1st July 2011 by the Reserve Bank of India, is the new benchmark rate for lending operations of banks. It is a tool which will help in bringing more transparency in lending operations of banks.
Base rate is defined as the minimum interest rate of a bank below which it is not viable to lend.It replaces the benchmark prime lending rate (BPLR) ,the interest rate which commercial banks charged their most credit worthy customer. A working group was constituted under the chairmanship of Shri Deepak Mohanty to review the benchmark prime lending rate. It was observed that the benchmark prime lending rate, which was introduced in 2003, had failed in its objective. The banks were lending below BPLR rates due to competitive pressures. Hence a need was felt for transition to a more transparent and effective interest rate mechanism.
Base rate includes all those elements of the lending rates that are common across all categories of borrowers. An illustrative methodology of calculation of base rate has been provided in the RBI guidelines. As per the methodology, base rate is arrived at by adding the following
- The cost of deposits ,which is the interest rate on total deposits
- Adjustment for the negative carry in respect of Cash Reserve Ratio(CRR) and Statutory Liquidity Ratio (SLR); The negative carry on CRR and SLR arises because the return on CRR balances is nil and the return on SLR balances is lower than the cost of deposits. Negative carry cost on CRR and SLR is calculated as difference between effective cost and cost of deposits, where
- the effective cost is the ratio of cost of deposits( adjusted for return on SLR investments) and deployable deposits(total deposits less the deposits locked as CRR and SLR balances)
- cost of deposits is the interest rate on total deposits
- Unallocatable overhead cost for banks which would comprise a minimum set of overhead cost elements, which includes components like legal and premises expenses, depreciation, cost of printing and stationery, expenses incurred on communication and advertising etc.
- Average return on net worth, which is the amount of net income returned as a percentage of shareholder’s equity. It is an indicator on profitability and return on shareholder’s funds.
Banks are free to choose any benchmark to arrive at the base rate. The interest on all categories of loans is determined with respect to the base rate except the following loans; (a) DRI advances ( that is Differential rate of interest scheme whereby banks offer financial assistance at concessional rates) (b) loans to banks’ own employees (c) loans to banks’ depositors against their own deposits. Base rate is to be reviewed at least once in a quarter and has to be disclosed to the public. Each bank arrives at its base rate separately. Banks are free to choose any methodology to arrive at the base rate which is consistent , appropriate and transparent.
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