The Reserve Bank of India has scraped the present PLR system and introduced base rate with effect from 1 April 2010. The new set of guidelines governing the base rate was released by the central bank. According to this, the cash reserve ratio, profit margin and various costs incurred by the bank such as the cost for maintaining the statutory liquidity ratio, running cost and cost of deposits will play a role in the base rate calculation.
The central bank has made it clear that borrower should be charged lending rate based on the new base rate. In its circular RBI said, “The actual lending rate charged to borrowers would be the base rate plus borrower-specific charges, which will include product-specific operating cost, credit-risk premium, and tenure premium.”
In the existing system, banks fix their PLR at their discretion. When interest rates are increased, banks too increase the PLRs, but when interest rates come down, PLRs are left untouched. This affects existing customers the most, as their variable loans are linked to the PLR. However, new customers are not affected, as banks pass on the benefit of lower interest rate by raising the discount.
Under the new base rate-based system, variable loans will be linked to base rate. As base rate is calculated based on the cost of funds, fluctuations in interest rate will be reflected in the base rate. Thus, the benefit is passed on to existing customers as well.
RBI has also stipulated that banks would not be allowed to charge below base rate for any loan, including commercial loans. While banks are free to fix their base rate, it will be common for all categories of borrowers.
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