Whenever a person borrows money from the bank there is an interest rate that the borrower has to pay to the lender. The base rate is the minimum rate of interest that the bank will lend money at and the borrower has to pay.
It can be considered as a basic rate of interest on which the actual rate a bank charges on loan to its customers is calculated.
So the base is the standard rate set by banks on the basis of the guidelines issued by RBI. Loans are given above the standard base rate to the borrowers and according to their credit ranking.
The RBI has given guidelines to banks to adjust their base rates from July 1, 2010, according to the prevailing market conditions and interest rate policies. Banks will update their base rates every few months if that is required. Banks can then communicate this to all their borrowers. So the base rate won’t be fixed forever.
The most important thing to keep in mind is the cost of money should not change. i.e., if the car loan cost about 12% or home loan cost 9%, this rate of interest charged to you will be no different going forward.
It is just the method used to explain about the rate fixed by the bank so as to ignore the bargaining by the borrowers. So we can say that the interest rates aren’t coming down as a result of this base rate implementation.Also Read: New Pension Scheme (NPS) Term Plan – the right way to take Insurance
Following this , the EMI on an existing loan is also not going to be charged. The borrower will continue to pay whatever he was paying up to last month in future months as well.
Banks used to price the loans on a complicated system called benchmark prime lending rate (BPLR). Each bank has its own BPLR method. It makes is difficult for borrowers to compare of interest across banks.
- TRANSPARENCY & UNIFORMITY: Banks have been asked by the RBI to ensure transparency in calculating the base rate, which is the floor rate for all the banks. Changes in the Base Rate Should also be conveyed to the general public form time to time through appropriate channels. Banks are required to provide information on the actual minimum and maximum lending rates charged to major categories of borrowers to the Reserve Bank on a quarterly basis.
- REDUCES BARGAINING: Base rate being a basic interest rate of the loans ignores the bargaining of borrowers. The Base Rate will be the minimum rate for all commercial loans, banks are not permitted to resort to any lending below the Base Rate.
- BENEFITS TO CUSTOMERS: It is expected that deregulation of lending rates will increase the credit flow to small borrowers at reasonable rate.
- APPLICATION TO LOANS: The Base Rate system would be applicable for all new loans and for those old loans that come up for renewal. However, if the existing borrowers want to switch to the new system before the expiry of the existing contracts, in such cases the new/ revised rate structure should be mutually agreed upon by the bank and the borrower.
IMPACT OF BASE RATE:
The impact of this new rate is however not likely to be much on borrowers but the new system is also expected to score over the old system in another way. To the extent it will cover nearly all borrowers: the base rate will more truly reflect interest rate changes arising out of monetary policy. For instance, when the recent repo rate hikes are factored, in the base rates of most banks are expected to be marked up. Correspondingly, the lending rates will also go up.
Under the old system — the PLR, being just a reference rate – any variation did not necessarily reflect policy changes. Even if they did, There was no guarantee that the borrowers would be charged more.
There is not likely to be an impact on base rates either, as the repo and reverse repo have not relation to the base rates.