Concept of Base Rate in Banking

The BPLR (Benchmark Prime Lending Rate) which was introduced in 2003 as a part of regulations in banking sector had its own shortcomings. It could not meet its original objective of increasing transparency in the system because under BPLR system, banks could lend below BPLR. Hence BPLR system is replaced with Base Rate system, with effect from June 1, 2010, to enhance transparency in lending rates of banks and to enable better assessment of transmission of monetary policy.

According to the guidelines set by the Reserve Bank of India Base Rate system includes all the elements of lending rates that are common across all categories of borrowers. Banks can determine their lending rates on loans and advances depending upon the Base Rate and may include appropriate customer specific charges. Current base rate of Indian banks is 10%. All loans were supposed to be priced with reference to Base Rate. But there is always a way to circumvent regulations.

Higher Base Rate will always create an unfavorable environment for borrowers. Hence they choose the route of Commercial Papers (CP), which have lesser interest rates than Base Rate.  Sale of Commercial Papers by Indian firms has grown 63% this fiscal till December 2014 to INR 1.27 lakh crore in the market according to RBI data. Companies pay about 8.5% on Commercial Papers and around 10-10.5% on bank loans. Now the question that arises to everyone is whether the Base Rate, which was supposed to improve the implementation of monetary policy through banking sector is becoming a constraint by letting market forces play.

To implement the monetary policies as per the will of Central Bank, Commercial Banks do play a major role as they are the institutions through which Central Bank executes its ideas to bring changes in the market. Hence the regulations set by the Central Bank should create favorable environment for the lenders and borrowers in the processing of increasing transparency and performance. In this respect Base Rate still remains as a question if it is a constraint for the banks’ free lending process.

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