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Unlike the BPLR that was set somewhat arbitrarily by bank, the base
rate will follow an explicit formula that factors in a bank's cost of
deposits, operating cost (expenses of running its brunch, for
instance), the cost of statutory drafts on bank funds imposed by
Reserve Bank of India( the CRR and SLR) and the profit margin.
The base rate will help borrowers to compare interest rates offered
by various banks and make the process of how banks arrive at
interest rates for loans more transparent.
Cont …
RBI has stipulated that banks cannot charge below the base rate for
most loans. (There are a couple of exceptions like agriculture loan
and export credit.) While the new model will ensure greater
transparency, it need not mean lower lending rate for borrowers.
In fact banks’ blue chip corporate could see some increase in their
cost of borrowing. The reason is somewhat simple. RBI allowed
banks to lend below their prime lending rate and the majority of
banks did the bulk of corporate lending at ‘sub-PLR Rates’.
the new reference rate for country’s largest bank is 9.5% most of the
other public sector banks have the base rate at 8%. This include
IDBI Bank 11.75%
Cont …
The best ‘credits’ for a bank could drive the hardest bargains. This
led to peculiar situation in which a bank whose official BPLR was in
the range of 14-16% was found lending its customers way below 5-
6%
The incentive for the ‘irrational’ pricing was to keep the ratio of non-
performing assets low, particularly in the wake of the Global financial
crisis and banks’ risk appetite waned and safety got precedence
over margins. The rate regime does away with this.
The introduction of base rate will ensure that if they are linked to it,
they will see automatic rise and fall in their existing rates.
Cont …
The RBI have asked banks not to change any fee for shifting the
prime lending rate to base rate. Importantly, even though banks are
going to change a fee- in excess of 1.5% in most cases – for
renegotiating the loan, it could still make sense in doing so.
Once you have shifted to the latest rate, this along with the linkage
with bank rate will ensure that future costs are saved.
The PLR regime was sticker. Banks took a longer time to align PLR
with the interest rate movements, “KVS Manian, head, retail
banking, Kotak Mahindra Bank.
However only home loan rates will be impacted by this. All other
retail loans, like auto and personal, are given at fixed interest rate
Cont …
But not all home loan customer would benefit linking their loans to
the new benchmarking system. For example if you can take a
teaser loan just few mounts back, it would still make sense to stick
to it.
And with SBI planning to continue its teaser rate of 8% for the next
few months, borrowers would continue to benefit.
“in Dual rate (or teaser) the loans, a borrower gets a fixed rate for
the initial years. This means there is predictability of monthly outgo
for this period and the borrower, in turn can plan the finance
accordingly without bothering about interest rate fluctuation,” said a
certified financial planner.
Cont …
For an existing borrower, there are some situations in which they will
benefit by shifting. In other cases, it may not make much difference.
Less than one year: if you have taken the loan just a year back,
around 90% of the equated monthly instalment (EMI)goes towards
repayment of interest and the rest towards principle.
If serving a floating rate loan for less than two years, financial
planners said it makes sense shifting the loans – even if the lender
is charging you a interest of 9-9.25%
Cont …
When a person shifts to base rate, the interest is likely to remain the
same. In addition, shifting is free. Shifting early to a new benchmark
would only help to get the benefits earlier. And if the existing loan
rate is around 1-2% lower than your existing rate, it makes sense to
renegotiate as well.
Of course, there will be charge. But you can easily get into a new
regime which is completely new and more sensitive to change.
During these years, the principle portion in the EMI account 60% or
more, as you get closer to repaying the loan. Shifting to base rate is
a tough call in such a sitution.
Cont …
Do your math and compare the advantages of BPLR vis-à-vis base
rate. If you have more than three years to repay the loan and you
still saving money on the EMI, go for it.
What you must do: shift to the base rate anyway. Because it will
ensure that you get advantage of loan rate fluctuations.