Wednesday, June 23, 2010

On the Base Rate

There is a lot of hype and noise about banks being advised to switch from the BPLR system to the base rate system. After the PLR system, the benchmark rate system and the benchmark PLR system which failed to bring in the 'much needed transparency' in pricing of loans, this is RBI's latest well meaning attempt. The key points of this move and its likely impact are

1. RBI has given banks the freedom to determine the base rate. It just wants it to be consistent and available for supervisory review.

The likely impact : I share the expectation of most analysts that the Base rate of PSBs and most large Pvt sector banks will hover around the rates that SBI sets - which many expect to be around 8%. Foreign banks may keep it lower. I dont rule out the possiblity of cartelization .
Now this BR will be the floor. What is likely to happen - which is in any case welcome - is that this will be market determined and banks will need to work backwards and tweek their cost structures. For the borrower though - particularly the SME, Retail customers - I am not sure if there will be any effective positive impact as banks are free to load fee structures over and above the base rates and there is no cap on the mark up over the Base rate.

2. All loan prices will need to be linked to this base rate ( with some exceptions).

The likely impact: The practice of quoting on treasury advised rates for short term buckets - say 30 days , 90 days, 180 days etc will be affected. Essentially well rated corporates will find this market closed - and they would move to the commercial paper market ( in which banks will again be their largest source of funds). That's a nice way to invigorate the short term corporate debt market !!!

3. External benchmarks are allowed , provided they are equal to or above Base rate at the time of sanction or renewal.

The likely impact : The MIBOR linked short term facility market for large corporates will vanish. However, banks and corporates may circumvent and innovate in the CP market

4. Current cap of BPLR as lending rate for loans upto Rs 2 lakhs is withdrawn

The likely impact : I ( hope to )see banks getting very active in the Micro Finance segment. I have been skeptical of the way MFIs do purely commercial business (more recently rather ruthlessly) in the guise of social inclusion and women empowerment. The major reason why banks - which are surely several shades better in their commercial activities - was this cap on lending rates. The operating costs in this space are rather high and now with this cap gone, if banks get their act right, the largest beneficiaries will be the small SHGs and entrepreuners.

5. The interest rate on rupee export credit has been deregulated

The likely impact : Increased transparency . Nothing more. Banks were anyway charging customers over and above the caps by way of charges under various names.

Net net ...

This move may bring in additional transparency - if the guidelines are followed in letter and spirit ( though it is common knowledge that it is followed in letter only). My guesstimate on the impact on the bank's profitability - NIL

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