Home loan – Base Rate To Change Lending Practice- Retail Customers To Benefit
In line with the Central Banks directive, banks have switched over to the base rate lending system from the prevalent Benchmark Prime Lending Rate (BPLR) from today onwards. This change has been introduced by RBI to make lending more transparent (eliminate arbitrary charges) and also to eliminate the cost disadvantage to small borrowers as they were cross subsidizing the mighty borrowers. In addition, policy transmission which is key to the success of the Central Bank’s policy, was not happening as desired because of the reluctance/lack of response from banks to change rates especially in the downward interest rate cycle.
The implementation of base rate, which is the minimum rate of interest that can be charged by banks, will make policy transmission effective and at the same time will bring an end to the era of banks arbitrarily charging differential rates to customers. The base rate system is applicable only to banks and not to finance companies. So housing finance companies, such as HDFC can continue with the PLR mechanism for charging interest rates.
As base rate announced by banks are as under.
Bank Base Rate Public Sector SBI 7.5% PNB 8% BOB 8% Union Bank of India 8% Central Bank of India 8% Andhra bank 8.5% Private Sector Axis Bank 7.5% HDFC Bank 7.25% ICICI Bank 7.5% Federal Bank 7.75%
The base rate differential among banks is not substantial as expected because the cost differential among banks is not substantial.
How will the base rate work?
Base rate will be the minimum lending rate charged by the banks for any kind of loan to which banks will add costs such as credit risk premium, product specific operating cost and tenure premium. As is indicated above, SBI has fixed the base rate at 7.5%. Suppose you need a car loan, to arrive at a car loan lending rate, SBI will add a spread to the base rate. Suppose after evaluation this spread is 6%, then your car loan interest rate would be 13.5%. The 6% is the spread charged by the bank for giving you a car loan which would encompass your credit risk, operating costs, tenure risk and other elements.
When there is a change in the interest rate by the Central Bank, the base rate will undergo a revision too. So if the Central Bank reduces rates and SBI has changed its base rate in accordance to 7%, which it will have to do to remain competitive, then all loans will float down by 0.5% giving the advantage to the customer. So if you have taken a home loan at 11.5%, the interest would now fall to 11%. However, if rates have risen, then the interest rate charged to you will rise accordingly.
What is in store for an existing loan customer?
Existing loan customers will have to act and not wait for things to happen, as the rule states that, they will continue to run with BPLR otherwise. They will have to approach the bank and talk to them about migrating to the new system i.e. the base rate. If the bank agrees, migration to base rate will happen when the contract comes up for renewal. Many experts are of the view that banks are unlikely to tinker with the existing loan rates any time soon, which will mean no change for existing customers.
How does it benefit the new loan customers?
New customers will benefit because of transparency. They do not have to worry about being charged an arbitrary rate because banks want to make up for the low rates they charge to large customers. They will know exactly how much spread is being charged. Also when interest rates fall, it will get passed to the customer by way of a lower interest rate which was not happening earlier as banks were reluctant to lower the BPLR.
Customers will have to be ready for a frequent change in interest rate, because a change in the base rate will result in a change in the interest rate charged with the spread remaining constant.
To make sure you get the best spread, manage your credit profile because that is among the important parameters determining your spread. Having a good credit profile will create a window of opportunity for you to bargain with banks to lower the spread.
The move by RBI to migrate to a more transparent system of pricing loans is certainly beneficial to the customer. Does this mean customers should look out for banks charging lower base rate for loans? Looking at only base rate to decide on the bank from which you will take a loan may not be intelligent. Remember, the bank has the flexibility to determine the spread on your loan which in turn will determine the interest charged to you. So while opting for a loan, let the comparison be on the overall loan cost and not the base rate.
6 Responses to “Home loan – Base Rate To Change Lending Practice- Retail Customers To Benefit”
Suresh said on July 6th, 2010 at 3:14 pm
Hoping this would help existing customer too, although i do not know how they calculate the interest rate from this.
amit w said on July 13th, 2010 at 5:32 pm
how about loans from NBFC’s. I have a home loan from Deutsche Postbank @ 11.75, thay are not declaring their base rates.
pls answer in case u know about base rate impact for existing customers of stand alone NBFC’s.
shwetabh said on July 13th, 2010 at 5:47 pm
Declaration of base rate would not affect your home loan immediately. Since the whole process of interest rate fixation has become more transparent, existing customer will be benefitted as and when RBI will change its rates.
Uttang Padhiar said on December 30th, 2010 at 3:08 pm
I dont think that Private Banks are giving options to their Existing customers to migrate from BPLR to Base Rates systems. HDFC, with whom i have Home Loan has denied having any knowledge about base rates system
Anindya said on May 24th, 2011 at 5:37 pm
These are wrong info. As from my experience with DB, I came to know Bank can also cjmahe the spread. So existing Customers are back to square one. Now bank can hold the Base rate but change spread thus forcing exisiting Customer to pay more.
Jignesh said on November 8th, 2011 at 10:50 am
DB bank offers lower spread to the new customer. They change the spread on the very first opportunity. Stay away from this bank.