Thursday, July 01, 2010

What is Base Rate? Understanding of Base Rate System India

Starting from July 1, all banks in India were moved to a “base rate” regime. What does this mean for all of us and how does this affect your existing borrowings? Here I try to clarify few questions which you may have:

What is the base rate?
When someone borrows money to buy car or house or electrical appliance or any thing else, there is an interest rate that one has to pay to the lender. The base rate is the minimum rate of interest that a bank will lend money at as per RBI guidelines. This is like floor interest rate below which RBI will not allow banks to lend money to any one.
Previously, banks used decide interest rates on the loans they offered, on a complicated system called benchmark prime lending rate (BPLR). Each bank has its own BPLR which is very difficult for borrowers to compare rates across banks.
Now, with the base rate, it will be easier for everyone to compare across banks and to get a more transparent sense of how the interest rate for the loan is being arrived at.

Is interest rate going to be cheaper? Will my EMI change?
The most important thing to keep in mind is that the cost of money is not changing, i.e., if a car loan cost about 12% or a home loan cost 9%, these rates of interest charged are not going to change.
Its just that the method used to arrive at this will be more clear to everyone. So, interest rates aren’t coming down as a result of this base rate implementation.
Following on from this, your EMI on an existing loan is also not going to change. You will continue to pay whatever you were paying up to last month in future months as well.

Should one change to a bank with a lower base rate?
As mentioned above, the cost of money is not changing. Most banks continue to charge a very similar rate of interest as they did before. Just because one bank has a base rate of 7% and another has a rate of 8.5% does not mean one should change to the bank with the lower rate.
On top of base rate there are additional amount of interest that the banks are charging, to cover its cost of doing business, and some compensation for the risk its taking in lending money.
So, after all these additions, its unlikely that the lending rates of one bank are any different to the rate being charged by any other bank. And there is no major advantage to shifting from one bank to another.

How does the base rate affect pre-existing loan?
For existing loans, there is nothing going to change. As mentioned above, interest rates aren’t changing in the economy. However, when any loan comes up for renewal, then it will be priced using the base rate formula.

Will the base rate remain fixed forever?
No, the RBI has given guidelines to banks to adjust their base rates depending upon the prevailing market conditions and interest rate policies. Expect to see banks update their base rates every few months if that is required. Banks will then communicate this to all their clients.

Share |


Embed Wave to Blogger