The banking sector’s benchmark, prime lending rate (PLR), had been in the center of controversy for long, which prompted RBI to constitute a panel to look into the issue in detail. According to the panel’s recommendation, the PLR system is being abandoned and a new system based on base rate is being introduced. One of the advantages of base rate system is that it will make lending process more transparent.
O P Bhatt, Chairman, SBI, India’s largest bank said, “The base rate will be transparent. Credit will henceforth revolve around the base rate as it will be the reference rate over which all loans will be priced and it will succeed in monetary transmission.”
One of the perennial complaints against PLR system was that many private sector banks were not passing on the reduction in policy rates to customers, but lose no time when the policy rates are hiked. This equals nullifying the monetary policy. The banks are also accused of favoring their corporate customers at the cost of individual customers and smaller companies, with the latter forced to bear the financial consequences. Many banks are lending lower than even funding cost to their most valuable clients.
A base rate system can solve the existing maladies plaguing the banking sector at present. The base rate is the rate below which a bank cannot lend even to their most favored customers. This is determined after analyzing a bank’s funding cost and operating cost.
With the base rate system coming into effect today, Indian banks will be forced to stop lending below 7%. The base rate for different banks will be in the range of 7%-8.75%, depending on each bank’s funding cost.
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