14890 - MONEY MARKET REVIEW Economic &...

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Unformatted text preview: MONEY MARKET REVIEW Economic & Political Weekly EPW june 19, 2010 vol XLV No 25 73 Team led by K Kanagasabapathy and supported by V P Prasanth, Rema K Nair, Bipin Deokar, Anita B Shetty, Shruti J Pandey, Vishakha G Tilak and Sharan P Shetty. Back to Base: Setting the Base Rate for Banks EPW Research Foundation In order to ensure greater transparency in setting lending rates, banks are expected to replace from 1 July the existing benchmark prime lending rate system with the new one of a base rate. Yet, the methodology and the approach that each bank will follow in setting this rate is still not clear. According to the Reserve Bank of India’s guidelines, determination of the base rate will depend on the cost structure of bank liabilities as also the capacity to charge lower interest rates for certain groups of borrowers. Therefore, the base rate is likely to hover around the minimum lending rates charged at present by different bank groups (public sector, private sector and foreign banks). Since these rates differ across bank groups, the base rates too are likely to differ, leading to some competition. However, given the new system that the banks are going to introduce, it will take a while before a clear picture emerges. 1 Introduction S tarting with the prime lending rate ( PLR ) in 1994, the lending rate guidelines for banks have followed a chequered path. The most crucial devel- opment was at the turn of the century when banks were given the freedom to charge loans at below the PLR , apart from the earlier system of having multiple PLR s. It was with a view to ensure greater trans- parency that a benchmark PLR ( BPLR ) system was introduced and multiple pre- scriptions of PLR were discontinued in April 2003. The Mohanty Working Group on BPLR constituted last year has come out with the recommendation to switch over to the Base Rate ( BR ) system, since the BPLR system had not ensured the needed transparency. Starting 1 July 2010, the banks have been directed to replace the BPLR with a new BR system. Though the July target date is not far away, the discussions bank- ers held early this month did not seem to have led to any definitive solution as to the methodology to be adopted for fixing the BR . As the banks wanted more time to set- tle with the new system, they have bought more time and hence the Reserve Bank of India ( RBI ) has allowed a transition period of six months, during which the banks are free to change their methodology. The basic issue seems to be that there are divergences in practice among different bank groups and hence the introduction of the new base rate is expected to lead to some competition between banks and bank groups. The news reports predict that while most public sector banks are likely to follow the SBI way with a base rate of around 8%, private sector and for- eign banks may go with a base rate of as low as 6%. There are also expectations that short-term lending portfolios may go in favour of private sector and foreign...
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This note was uploaded on 07/31/2010 for the course FIN 201 taught by Professor Hcverma during the Summer '10 term at IIT Kanpur.

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14890 - MONEY MARKET REVIEW Economic &...

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