BPLR is dead...Long live the base rate

Effective July 1, all banks operating in India started adopting a new system of base lending rate, replacing the old system of BPLR (base prime lending rate) introduced in 2003. SBI was the first to fix its base rate at 7.5%, while other large nationalised banks all fixed their base rate at 8%. HDFC Bank fixed its base rate at 7.25%, while ICICI Bank and Axis Bank fixed the same at 7.5%. The base rate for public sector banks is in the range of 7.5% to 8.25%, while that for private sector and foreign banks is lower by 50-100 basis points.



IIFL report says "we don’t expect incremental lending to be purely driven by the respective level of base rates, since banks are still allowed to add product-specific costs, risk premium and tenure premium on top of the base rate. We believe that overall lending will continue to be purely market-driven, since the banks have enough flexibility to manoeuvre the premium charged over the base rate." Thus, the impact on net interest margins (NIMs) isn’t likely to be material, according to IIFL. It remains positive on the Indian financial sector, and expects further pick-up in loan growth to 18-20% in FY11, rise in fee income, and lower credit charges.

The introduction of base rate mechanism in India's banking system is unlikely to impact the overall profitability of the banking system, while it will enhance competition in the short-term lending space, Crisil Ratings said. The base rate system is also expected to enable banks to respond more efficiently to monetary policy measures, the rating agency said. The new mechanism will limit banks' flexibility to provide finer rates, Crisil said.

All new loans and advances sanctioned on July 1 and onwards will attract interest rate as per the new system to be determined with reference to base rate. The Reserve Bank of India (RBI) has stipulated that all banks should arrive at a base rate for lending below which no loans can be extended. This has been done to curb the practice of retailers and small companies subsiding large companies. Once the new rule comes into force on July 1, large corporates, who benefited from the so-called sub-prime lending rate (PLR) lending, will have to pay at least the base rate. As per the new norms, existing customers will have to migrate to the base rate when their loan contract comes up for renewal. The new rule does not apply to finance companies, including mortgage finance firms.