What is Base Rate in Indian Banking? And Who Decides Base Rate in India

The system of base rate has been introduced by Reserve Bank of India as a reformative measure to eliminate the risks involved in bank’s lending system. All the banks were allowed time required for adopting the changes in computing new base rate till December 2010. This time was further extended to 30th June, 2011. Earlier the banks were allowed to fix own methodology and Benchmark for calculating own lending rate.

The commercial banks like other business firms in a competitive market used to try to keep own lending rate (PLR or Prime Lending Rate) lower than others for attracting more borrower for more business, the bank loan was becoming cheaper everyday to certain class and category.

This led to manipulating and rate cutting among the banks.

This competition of lowering lending rate were taking out a major chunk of the bank’s profit which was never a cheering news to the RBI, the banker of bankers in our country, and it was becoming an increasing threat to the transparency of the system. The intervention of RBI became more needed after the recent crisis with world financial crunch.

The previous system of lending was known as BPLR or Benchmark Prime Lending Rate and was introduced in 2003, but that failed to fulfill its objective and the banks were able to lend below the BPLR.

As per the direction of RBI all banks must have to follow the new Base Rate system from 1st July, 2011. The main aim of the present Base Rate system is to bring transparency in bank’s lending business and strict adherence to the monetary policy of the central government.

Under the previous system the banks were able to discriminate customers by lending at different rates to different categories of customers. Cheaper rates were charged from their preferred class of customers or big corporate houses and it was always the retail customers who paid more.

Base Rate in Indian Banking

The Reserve Bank of India has published an Annexure showing different methods for arriving at the base rate for different tenures. The items given in the annexure for calculating Base Rate includes all the influencing factors and cost elements like cost of deposit, direct and indirect expenses and overheads, any negative balance brought forward, etc.

The banks are free to choose any method given in the Annexure but the banks are accountable to the public to disclose the methodology used for their own base rate computation.

The base rate system is not applicable for the following loans:

a)    Loan for agricultural purposes

b)    Loan to own bank employee

c)    Loan against any FD

d)    Loan given to exporter.

Who Decides Base Rate in India

The Reserve Bank of India has given a guide line through its publication where it has mentioned the criterion upon which a bank can compute its own base rate. The commercial or lending banks are free to choose any method they think suitable but have to declare their way of calculation to the public.

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