RBI's Messy Monetary Policy

Reserve Bank of India on 20 September 2013 announced its monetary policy review, listing out various measures and reasons behind them.

But RBI seems to be in a lot of confusion. In the last two years, the monetary policy has been completely botched, to say the least. I was writing my thoughts on the RBI's latest policy announcements. But in between, I've come across this brilliant piece.

Dr Ajay Shah has written a fabulous article on the RBI's wavering messy policies:

Please read the same at:

http://ajayshahblog.blogspot.in/2013/09/rbi-statement-failed-to-reduce.html

I share similar views as expressed by Dr Ajay Shah.

------------------------------------------------------------------------------------------------------------------------------

Disclaimer: The author is an investment analyst, equity investor and freelance writer. These are his personal views. He blogs at:

http://ramakrishnavadlamudi.blogspot.in/

http://www.scribd.com/vrk100

Connect with him on twitter @vrk100

Market Outlook-VRK100-01Aug2011

Market Outlook


Rama Krishna Vadlamudi, HYDERABAD 01 August 2011


In its latest review of the monetary policy, Reserve Bank of India has raised interest rates by 50 basis points against the consensus market estimate of 25 basis points. The reverse repo rate is increased to 7.0 per cent and the Marginal Standing Facility rate is hiked to 9.0 per cent. The unexpected 50-basis point hike has caught the stock and bond markets unawares and both the bond prices and stock prices have reacted negatively to the news. The corporate quarterly results continue to be mixed with several large- and mid-cap companies declaring their results. However, stock market has been punishing companies not only with poor performance but also with average performance. Public Sector Banks have been reporting a substantial jump in loan provisions due to rising non-performing assets.

RBI’s Monetary Policy-from baby steps to dinosaur steps

Following an aggressive move by Reserve Bank of India to increase its Repo rate by 50 basis points (under its liquidity adjustment facility or LAF) from 7.5 per cent to 8.0 per cent with effect from 26 July 2010, many banks like, Punjab National Bank, IDBI Bank, Oriental Bank of Commerce, Bank of India, DCB, Yes Bank, Corporation Bank, and Bank of Baroda, have raised their base rates by 40 basis points (100 basis points = one per cent) to 75 basis points. This is likely to push up interest rates of corporate loans, housing loans and auto loans.

RBI started raising interest rates since February 2010 gradually with 25 basis points raise each time which was described as ‘baby steps’ by RBI itself. But in a matter of just under three months, RBI has raised the Repo rate by 125 basis points signifying a change to a hawkish monetary policy stance. Clearly, RBI is worried about inflation and wants to control the stubborn inflation with stern measures.

First Quarter results

 BHEL has recorded a 22 per cent rise in net profit for the first quarter aided by surge in other income. Its order book decreased to Rs 1,59,600 crore as on 30 June 2011.

 RIL has posted an increase of 17 per cent in net profit aided by higher refining margins and other income. Sales growth for the quarter was 39 per cent.

 Maruti Suzuki’s net profit has gone up by 18 per cent mainly due to higher other income, while sales were up by a mere 3 per cent.

 ICICI Bank’s first quarter net profit surged by 30 per cent due to lesser loan provisions following improved asset quality.

 Andhra Bank has recorded an increase of 21 per cent in net profit while that of Corporation Bank was a mere five per cent.

 Syndicate Bank has recorded a 29-per cent jump in net profit due to surge in other income.

 Grasim Industries reported a surge in net profit by over 30 per cent due to improved realizations from VSF and cement businesses.

 Hindustan Unilever has posted good results with a rise in net profit of 18 per cent in the first quarter helped by volume growth, cut in advertisement cost and better product mix.

 Punjab National Bank has shown a mere 3 per cent increase in net profit due to aggressive loan provisioning, though it managed to keep the net interest margin at 3.84%.

 Bank of Baroda has posted decent numbers with a rise of 20% in net profit aided by interest income and fee income. Compared to other public sector banks, BOB’s loan book is of superior quality.

 Canara Bank’s net profit was down by 28 per cent due to sharp rise in loan provisions and steep decline in treasury profits.

 UltraTech Cement has reported a rise of 22% in its quarterly net profit.

 ITC’s net profit has grown by 25 per cent while sales growth was 20 per cent.

Land Acquisition Bill

Government of India has come out with a draft Land Acquisition Bill which aims to provide better market values to land owners and to safeguard the livelihoods of the project-affected people. The salient features of the Bill are:

 Government will not acquire land for private companies

 In urban areas, land owners will get a minimum compensation of twice the market value

 In rural areas, land owners will get a minimum compensation of six times the market value

 A comprehensive rehabilitation package for land owners and the landless people affected by the project

 The Bill will enjoy primacy over specialized legislations

Karnataka Lokayukta Report

Karnataka state ombudsman Mr Santosh Hege has named several firms, like, JSW Steel, Adani Enterprises, NMDC and Sesa Goa to be involved in illegal mining of iron ore in Bellary district of Karnataka between 2006 and 2010. The share prices of these companies have crashed after the report made public. The report estimated a loss, in taxes and royalty, of Rs 16,085 crore to the Karnataka Government. Following the report, the Supreme Court has suspended iron ore mining in Bellary district.

SEBI takeover code

On 29 July 2011, the Securities and Exchange Board of India (SEBI) has raised the threshold limit for open offer to 25 per cent from the existing 15 per cent. The capital market regulator, SEBI, has also decided to increase the open offer size to 26 per cent from the present 20 per cent. What this means is, from now onwards, companies in India can acquire shares worth up to 25 per cent of the target company’s paid-up capital without triggering any open offer. Once this 25 per cent threshold limit is reached, the acquiring company has to come out with an open offer to acquire another 26 per cent stake in the target company. SEBI has done away with the provision of non-compete fee. Till now, an acquirer was allowed to pay non-compete fee on takeover.

Debt pangs continue for the United States

The deadlock about raising the $14.3-trillion US debt level continues between the US president and the Congress. If no consensus is reached between the warring parties, the US Treasury Department will run out of money to pay its bills on August 2nd. The Republican Party seems to be blackmailing the US president about debt reduction. Rating agencies have threatened to downgrade US’ AAA-rating if the US lawmakers fail to reach an accord. However, rating agencies may still downgrade the US rating due to the fact that fiscal deficit is a long-term problem. The new managing director of the International Monetary Fund, Christine Lagarde, has warned that the US debt default/shock will have huge repercussions not only for the US but also for the rest of the world.

The huge US fiscal deficit is a big problem for other countries which hold their foreign exchange reserves in US government debt. Some of the biggest holders of the US debt are: (in USD billion) China - 1,160; Japan – 907; the UK – 333; and Brazil – 190. Other investors in the US government debt are banks, pension funds, sovereign wealth funds and individual investors.

The outlook

Sensex ended down at 18,197 for the last week and Nifty was down at 5,482. As I am writing this, the flash news is that an agreement has been reached in the US to reduce government debt. This will be a big relief for the markets around the world. However, in the medium to long term, markets will be guided by what is happening in the US and their decisions on the deficit-cut will be closely tracked. For over 10 years, the US has been living beyond its means. Between 2001 and 2011, the government debt has almost trebled from $ 5.8 trillion in 2001 to $ 14.3 trillion in 2011 (one trillion is equal to one lakh crores).

With Indian Parliament opening its monsoon session today, the market will be watching the progress of several pending bills which will have huge consequences economically and socially. The market will be watching the quarterly results also.

Snippets

 State Bank of India Commercial and International (SBICI) Limited was merged with State Bank of India effective 29 July 2011.

 The US gross domestic product has increased by 1.3 per cent annual rate during the second quarter (April to June 2011). The growth rate of 1.3 per cent is much below the expected rate of 1.8 per cent due to weak consumer spending. The US economy contracted at an annual average rate of 0.3 per cent between 2007 and 2010 as per the latest estimates.

 SEBI, the capital market regulator, has reintroduced entry load for mutual funds. Existing investors have to pay an entry load of Rs 100 per transaction. New investors have to pay Rs 150 per transaction. However, investments up to Rs 10,000 will not attract any entry load.

 SEBI has proposed to allow setting up of KYC Registration Agencies, which will enable mutual fund investors to have a single and uniform KYC (know your customer) procedure across the securities market.

 Mogul Resources Limited is coming out with an initial public offer of 7.5 million Australian dollars with a listing on the Australian Securities Exchange (ASX) in October. The company is exploring for copper, gold and other metals in Rajasthan, Karnataka and Andhra Pradesh.

 Anshu Jain has been named as co-chief executive officer of Deutsche Bank Group along with Juergen Fitschen. They will take over from the current CEO, Josef Ackermann, next year.

 Moody’s has cut Greece’s credit rating by three notches.

Quote of the week

“If you hold your currency perennially depreciated, it amounts to giving away goods for free. That is good news for everybody except the person giving it away thus. The right policy is to sell cheap for a while to get people used to your product and then raise the price and reap the benefit of the habit of buying your goods that you have inculcated in people.” – Kaushik Basu, chief economic advisor, on being asked whether it is a good idea for China to let its currency, Yuan, appreciate now.

Disclaimer: The author’s views are personal. The author has a vested interest in the stock markets. Before taking investment/trading decisions, consult your personal certified financial planner/adviser.

About the Author: Passionate about financial markets. Watches equity, bond and currency markets from a macro point of view. Loves writing articles on financial markets. So far, has written more than 120 articles running into about 720 pages of original content, which have attracted more than 165,000 readers on SCRIBD. www.scribd.com/vrk100

RBI Monetary Policy - Mid-Quarter Review of June 2011-VRK100-17062011

RBI Monetary Policy

Mid-Quarter Review of June 2011

Rama Krishna Vadlamudi, HYDERABAD June 17, 2011

As expected, the Reserve Bank of India has raised its benchmark Repo rate (under its Liquidity Adjustment Facility or LAF) by 25 basis points to 7.50 per cent when it announced the mid-quarter monetary policy on June 16, 2011. The new rate is with immediate effect. The Reverse Repo rate under LAF and the interest rate under Marginal Standing Facility are linked to Repo rate. As such, both the Reverse Repo rate and Marginal Standing Facility rate stand increased to 6.50 per cent (one per cent below Repo rate) and 8.50 per cent (one per cent above Repo rate) respectively with immediate effect.

Since the beginning of year 2010, RBI has been increasing the interest rates continuously. The latest Repo rate hike is tenth increase since March 2010 when RBI increased Repo rate from 4.75 per cent to 5.00 per cent – the cumulative increase in Repo rate amounts to 275 basis points (or 2.75 per cent) in the last 15 months.

Rationale

What is the rationale behind RBI’s latest increase in rates?

 Inflation rate of 9.1 per cent (provisional figure) remains at highly uncomfortable levels due mainly to high commodity prices

 Non-food manufactured goods prices have gone up in May 2011 in addition to higher inflation of food articles

 Manufacturers are passing on the increase in wage cost and service cost to consumers as is evident in the inflation indices

 Private consumption is at higher levels even though there is some deceleration in some sectors, like, automobiles

Impact

The present rate hike from RBI is on the expected lines. The stock market as well as the bond market has weakened considerably well before the announcement of the RBI’s rate hike. In its Annual Policy announced on May 3rd this year, RBI raised the Repo rate by 50 basis points in one go. After the Annual Policy announcement, commercial banks were quick to increase their lending rates suggesting strong monetary policy transmission, which indicates the ability of the RBI to pass on its policy initiatives to the broader economy.

On June 16, 2011, the benchmark Sensex closed at 17,986 down 0.81 per cent over the previous day’s close and the Nifty was down at 5,397. The downtrend is likely to continue till the next policy announcement by RBI. One can expect Sensex to drift down another 10 per cent from the current 18,000-level.

The bond market too had been reacting negatively in the last six weeks or so to the expected increase in RBI rate hikes. The benchmark 7.80 per cent 10-year Government of India security maturing in 2021 was showing signs of weakness till the policy announcement yesterday. But, after the rate hike announcement mid-day, the bond prices have gone up and the benchmark paper’s yield declined to 8.30 per cent from 8.38 per cent the previous day (bond prices move in opposite direction to bond yields). The future for Government bond prices looks weak now.

Commercial banks have been enjoying good net interest margins. As such, they may absorb some of the present rate hike themselves while some portion of the burden will be passed on to borrowers. Banks may increase their deposit rates also depending on the credit offtake. Overall, borrowers can expect rate increases in home loans, car loans, coporate loans, etc. This in turn will adversely affect domestic consumption.

Outlook

It is not clear whether the RBI’s actions in the last 15 to 18 months have been able to contain inflationary expectations even as GDP growth rate has moderated to 7.8 per cent in the January-March 2011 quarter from 9.4 per cent in January-March 2010 quarter. There is visible slowdown in manufacturing as indicated in the Industrial Index of Production (IIP). In the month of April 2011, IIP is at a sober level of 6.3 per cent. However, the apprehensions regarding the effectiveness of monetary policy in containing growth-induced inflation remain unanswered at this point of time.

Diesel price may be increased by the Government as the fiscal deficit may go out of control this year due to higher cost of imported crude oil. The subsidy burden of diesel, LPG and kerosene is too heavy for the Government. The liquidity situation seems to be comfortable now. Credit growth is around 21 per cent year-on-year above the RBI’s indicative projection of 19 per cent. The monsoon is most likely to be normal this year providing some hope on the food inflation front.

With stock markets languishing in sideways to downward trend, it remains to be seen whether the Government will be able to go ahead with its disinvestment programme. If it fails to raise additional money through disinvestment, its hold on the fiscal situation will deteriorate leading to higher fiscal deficit. Higher fiscal deficit may translate into higher interest rates in future. If the Government increases diesel prices, it may further accentuate inflationary expectations in the economy.

The financial markets have been expecting another rate hike of a minimum of 50 – 75 basis points before the end of this fiscal year. However, what needs to be emphasized is that RBI will be keenly watching the important data, like, inflation, GDP growth, tax collections, disinvestment of public sector companies, oil prices, global cues, and others, before making further moves on its fight against inflation monster.

In the last 15 months, RBI has been increasing interest rates as per market expectations as inflationary pressures have been building up in the economy. But the same cannot be said for the future RBI’s moves on interest rates. Next time, we need to expect the unexpected from RBI. Even though many experts and analysts have been expecting 50 to 75 basis points increase, we need to keep our fingers crossed and keep a close eye on data.

Repo rate: The overnight rate at which banks borrow money from RBI by pledging Government securities with RBI

Reverse Repo rate: The overnight rate given by RBI to banks when the latter keep their surplus funds with RBI (one per cent below Repo rate)

Marginal Standing Facility (MSF): Banks can borrow overnight from the RBI’s MSF up to one per cent of their respective net demand and time liabilities or NDTL. The rate of interest on amounts accessed from this facility will be 100 basis points (one per cent) above the repo rate.

LAF – RBI’s Liquidity Adjustment Facility

RBI – Reserve Bank of India,

LPG – Liquefied Petroleum Gas

GDP – Gross Domestic Product or national income

IIP – Index of Industrial Production

Disclaimer: The views of the author are personal.

The author writes copiously on financial markets – equities, bonds, currencies, taxes, Indian economy, etc. You can read these articles on:

www.scribd.com/vrk100

or

www.ramakrishnavadlamudi.blogspot.com





- - -

Monetary Policy-Reserve Bank of India-September 2010 Mid-Quarter Review

MONETARY POLICY-
RESERVE BANK OF INDIA
MID-TERM REVIEW OF
SEPTEMBER 2010




Rama Krishna Vadlamudi, HYDERABAD September 22, 2010

To read this article in a reader-friendly PDF document, just click:

http://www.scribd.com/37969098

India’s national income (GDP) has expanded by 8.8 per cent during the first quarter of 2010-11. The Index of Industrial Production (IIP) has gone up by 13.8 per cent in July 2010 compared to the same month last year. Services sector in India is booming. With bountiful monsoon, Agricultural Production is expected to post buoyant growth. Food inflation is more than 15 per cent. 

 

Inflation based on Wholesale Price Index (WPI) remains almost at more than 10 per cent since February 2010; though it has come down to 8.5 per cent in August 2010 (base year: 2004-05). India’s imports have risen substantially in the last few quarters, while export growth continues to be mild. Global recovery seems to have faltered in the last few months.

Against this backdrop, the Reserve Bank of India (RBI), in its mid-quarter review of Monetary Policy announced on September 16, 2010, has raised policy rates to contain inflation. This Mid-term Review of Monetary Policy by RBI is the first of its kind, whose introduction was announced by RBI in the July 2010 Quarterly Review.

 

Monetary Measures:

The following are the monetary measures undertaken by RBI on September 16, 2010:

1) LAF-Repo Rate is increased by 25 basis points to 6.00 % wef Sept. 17, 2010

2) LAF-Reverse Repo Rate is hiked by 50 basis points to 5.00 % wef Sept. 17, 2010

3) The Cash Reserve Ratio (CRR) is kept unchanged at 6.00 %

4) Bank Rate has been retained at 6.00 %

5) Saving Bank rate has been kept unchanged at 3.50 %

LAF corridor further shortened:

LAF Corridor is the excess of LAF-Repo Rate over the LAF-Reverse Repo Rate. Between July 2008 and now, the corridor was brought down aggressively from a high level of 300 points to 100 points. Liquidity Adjustment Facility (LAF) is a mechanism by which RBI adjusts daily liquidity in the domestic money markets by injecting funds (at repo rate) or by withdrawing them out (at reverse repo rate).

LAF corridor is important from the viewpoint of short-term interest rates. Short-term interest rates, usually represented by call money rates, are supposed to move in a range between repo rate and reverse repo rate. RBI would use this corridor to contain any volatility in short-term interest rates.

Impact on Markets:

RBI has been consistently raising policy rates and reserve ratios since February 2010. The following table illustrates this:

POLICY RATE/RATIO      HIKED FROM           HIKED TO             HIKE in basis points *

Cash Reserve Ratio            5.00% in Feb.2010       6% in Sept.2010               100

Repo Rate-LAF                 4.75% in Mar.2010       6% in Sept.2010               125

Reverse Repo rate-LAF     3.25% in Mar.2010       5% in Sept.2010               175

* one per cent is equal to 100 basis points (bp)

Stock market has been ignoring these consistent policy rate hikes. Till now, the markets have been blaming the RBI for “being behind the curve”, meaning that RBI is not raising policy rates in line with the spiraling inflation. By ignoring the increase in policy rates till now, the Market itself seems to be “behind the curve!” 

 

While RBI increased CRR by 100 bp and repo rate by 125 bp in the last seven months signifying hardening of interest rates; the benchmark Sensex has gone up from 16,000 plus level in February 2010 to 20,000 plus now, showing a growth of almost 25 per cent. This is quite a surprising thing considering the fact that consistent increase in interest rates is interpreted as a growth dampener for corporate profits. 

 

In future, one can expect the market to price in the policy rate hikes and the stock indices may show some weakness. However, it is difficult to tell at what point of time the stock markets will fully reflect the ground realities; as long as the inflows come in through the Foreign Institutional Investors (FII), who have been pouring money into India’s stock markets. As per SEBI data, FII inflows into the stock market are around USD 17 billion or Rs 79,000 crore during the 2010 calendar year.

However, bond market has been pricing in, to some extent, the steps being taken by RBI to contain inflationary pressures in the economy. While the Government borrowing has increased substantially this year, the windfall revenues for the Government from telecom auctions in 3G and broadband wireless access have boosted the confidence of the bond market. But for these windfall revenues, the government bond prices would have fallen much more.

Bank deposit rates will further go up. As of now, bank depositors are earning negative interest rates. In the past few months, depositors are getting 7 to 8 per cent per annum for three-year deposits; whereas inflation is more than 10 per cent. This means, inflation at more than 10 per cent is eating away whatever pittance they earn from interest on their deposits.

 

Interest rates on home loans will be increased gradually. Corporate loan rates too will be hiked as banks start raising their lending rates depending on the liquidity situation. Rates of commercial deposits and commercial paper have already gone up substantially.

 

Is RBI done with rate hikes?

In its mid-quarter review, the RBI has indicated that inflation rates have reached a plateau, but cautioned that they would remain at higher levels for some more time. RBI expects inflation to moderate after some time. Some experts believe that RBI’s rate hikes have almost come to an end considering the fact that global growth remains muted as of now with US unemployment rate stagnating at 9.6 per cent for several quarters.

However, some disagree with RBI’s optimistic view on anticipated inflation moderation. With GDP growing at 8.8 per cent in first quarter and IIP surging to 13.8 per cent in July, it is difficult to give credence to official figures and pronouncements on inflation. With robust inflows in the form of portfolio money (FII inflows into stock market), inflation will remain at elevated levels for considerable period of time. All indications are that the odds are against the optimistic views being expressed by the Government functionaries and RBI.

RBI says, “Inflation remains the dominant concern in macroeconomic management.” Food inflation is still a worrying factor in containing overall inflation for the RBI and the Government. To sum up, one can expect more rate hikes from RBI in the coming quarters.

 

Data Integrity

Central Banks, in general, are known for their vagueness in policy pronouncements. However, RBI was rather candid and expressed its doubts about the authenticity of index of industrial production (IIP) figures put out by the Government authorities. The IIP showed a tepid growth of 5.8 per cent in the month of June 2010; however, it surged to 13.8 per cent in July 2010. These wild swings in monthly industrial production numbers impart an element of confusion in the minds of policymakers and market players; thus making the monetary policy formulation difficult for RBI.

RBI’s observation comes at a time when doubts have been expressed about the integrity of India’s GDP data published by the Central Statistical Organization (CSO), a Government body. It may be noted that the Government revised its first quarter GDP numbers for 2010-11 within 24 hours. GDP growth rate as measured by expenditure at market prices was, at first, put at 3.7%; but, within 24 hours, it was revised upwards to 10%! It is no wonder that India’s Prime Minister Manmohan Singh once remarked that, “India’s data are not reliable!”

 

- - -

 

 

Notes:

FII-Foreign Institutional Investor

IIP-Index of Industrial Production

LAF-Liquidity Adjustment Facility of the RBI

RBI-Reserve Bank of India

SEBI-Securities and Exchange Board of India



Disclaimer: Views of the author are personal.

----------------------------------------------------------------------------------------------



For author’s articles on financial markets, just click any one of the below links:

http://www.scribd.com/vrk100

http://www.ramakrishnavadlamudi.blogspot.com/

http://groups.google.co.in/group/random-thoughts-on-investments/files?hl=en&&sort=date

THE BEST OF MY STUFF ON Reads

http://www.scribd.com/vrk100


1. Goods and Services Tax-GST-an introduction 8 453

2. Currency Futures in India-UPDATE 5 100

3. Income Tax Slabs 2010-11 for salraied class, etc. 4 855

4. India Budget 2010-11-Highlights and its impact 4 000

5. Direct Taxes Bill 2009-Impact on salaried class 3 686

6. IFRS-A Guidebook on Convergence to Global Accounting Standards 3 227

TOTAL READS have crossed 1,10,000!

From A Total of 105 Documents in about 13 months

New Base Rate System of Bank Loan Pricing-VRK100-13Jun2010

Follow @vrk100

If you want to read this 20-page document in a PDF, please download this from : http://www.scribd.com/doc/32989421

BASE RATE - NEW SYSTEM OF LOAN PRICING BY BANKS IN INDIA

ABBREVIATIONS USED:

BPLR             : Benchmark Prime Lending Rate

BRS                : Base Rate System

CASA             : Current Account and Savings Bank Accounts (low-cost deposits)

CD                  : Certificate of Deposit;                    CP  : Commercial paper;

CRR               : Cash Reserve Ratio;                       DRI : Differential Rate of Interest

G-Sec             : Government Security

LAF                 : Liquidity Adjustment Facility of the RBI

MIBOR           : Mumbai Inter-bank Offered Rate

PLR                : Prime Lending Rate

RBI                 : Reserve Bank of India; and,            SLR : Statutory Liquidity Ratio

EXECUTIVE SUMMARY

Come July 2010, the Indian banking sector is going to witness some fast moving and high-impact developments. India’s banking regulator, Reserve Bank of India, is ushering in a new Base Rate System (BRS) replacing the existing, outdated and non-transparent Benchmark Prime Lending Rate (BPLR) system. At present, sub-BPLR lending is rampant in the system. Once the new BRS comes into effect, one expects that such a non-transparent and discriminatory system will come to an end.

RBI, in April 2009, announced the appointment of a working group to study the relevance of the existing BPLR and suggest ways to improve the system. The Working Group, headed by Deepak Mohanty, submitted its report in October 2009. Based on the recommendations of the working group, RBI released its draft circular on BASE RATE system on February 10, 2010. After getting feedback from banks and other stakeholders, RBI had issued its Final Guidelines on April 9, 2010. The new Base Rate System would be effective from July 1, 2010.

The Committee’s recommendations have been partially accepted by RBI. In future, banks will not be able to lend at rates below the Base Rate. The Base Rate will be based on the bank’s cost of deposits/funds, negative carry on SLR/CRR, unallocatable overhead cost and average return on net worth. The actual lending rate to be charged to borrowers will be Base Rate plus product-specific overhead cost, credit risk premium and tenor risk premium.

So far, no bank has announced its Base Rate. They may announce the Base Rates in the next few weeks before the deadline of July 1, 2010. The author expects the Base Rate range to be between six and nine per cent due to wide differences in cost of funds, NPAs and other costs.

This article examines, in a comprehensive manner, the contents of the report of the working group and the RBI’s Final Guidelines issued on April 9, 2010. The author has tried to bring in all the aspects of the new system in a simple and easy language that is understandable by all. The article is written in a question-and-answer format, which is one of the easiest. The article’s highlights are:

ü        Why is RBI switching over to the new Base Rate System

ü        What will be the impact of the new system

ü        What are the RBI’s Final Guidelines

ü        Whether RBI has accepted the Committee’s recommendations fully

ü        What are the differences between the Committee’s recommendations and RBI’s Final Guidelines

ü        How is the Base Rate calculated

ü        How is the actual lending rate worked out

ü        What is the likely range of Base Rates by banks

At the end, the following annexures are provided for additional reading:

I    :   Full recommendations of the Deepak Mohanty Committee

II   :   Formulas for calculating the Base Rate

III  :   TIMELINE: Evolution of BPLR since the early 1990s to 2004

IV  :  Some important terms explained

1. What is Base Rate?

Base Rate is the minimum lending rate below which a bank can not lend to borrowers except in a few cases. Base Rate is being implemented in India with effect from July 1, 2010. From that date, the existing Benchmark Prime Lending Rate (BPLR) will cease to exist and the new Base Rate System will come into effect. Base Rate will differ from bank to bank depending on individual bank’s cost of deposits/funds and other criteria.

2. Why is RBI changing the loan pricing system?

There is a public perception that banks have been offering lower lending rates to big corporate customers, while charging higher rates from small borrowers in the retail, small business and agriculture segments. This amounts to cross-subsidization. RBI has received several complaints to this effect from various industry bodies and associations. RBI has taken this view into consideration. For several years especially since the early 2000s, RBI had tried to bring in a transparent system of lending rates in the banking system. After trying very hard, RBI has genuinely felt that banks’ BPLRs are not transparent and there is a large-scale sub-BPLR lending.

Downward stickiness in rates: RBI has observed that whenever RBI raises policy rates and reserve ratios, banks are quick to increase their loan rates. But, when RBI reduces policy rates and reserve ratios, banks respond very slowly effecting decreased lending rates with a considerable time lag. Such a phenomenon is called downward stickiness in rates. RBI is of the view that it is adversely impacting the monetary transmission mechanism in the banking system.

Due to competition, banks have been offering loans to first class borrowers with high credit rating at rates much below the BPLR in a non-transparent manner. RBI opines that banks’ lending at sub-BPLR rates is not in tune with the central bank’s objective of bringing transparency to the loan rates. BPLR has fallen short of RBI’s expectations to work as a reference rate or benchmark rate.

Keeping the above in mind, RBI had set up, in April 2009, a committee under the chairmanship of Deepak Mohanty to look into the existing BPLR system and suggest a suitable alternative system for pricing bank loans. The Deepak Mohanty Committee’s recommendations were made public in October 2009, which suggested shifting from the current BPLR to a new system called Base Rate System. After getting feedback from banks and other stakeholders, RBI had issued its Final Guidelines on April 9, 2010.

3. What are Deepak Mohanty Committee’s Recommendations?

The important recommendations are:

ü        The concept of BPLR is outdated and is out of sync with the present market conditions and it should be replaced with a new Base Rate System

ü        Base Rate would be based on one-year card rate on deposits, loss incurred by banks for SLR/CRR, overhead cost and average return on net worth

ü        The actual rate charged to borrowers would be Base Rate increased by operating costs, credit risk premium, tenor premium and others

ü        Banks should not lend below the Base Rate, except in a few cases

ü        At present, the Government administers loans of up to Rs 2 lakh to small borrowers, under priority sector & others. These administered rates shall be discontinued and these loans can be brought under the Base Rate system.

(For full set of recommendations, see Annexure I at the end of this article.)

4. Whether RBI has accepted the recommendations?

RBI had made public the report of Deepak Mohanty Committee in October 2009. After getting feedback from banks, RBI had issued the final guidelines on Base Rate System on April 9, 2010.

RBI’s Final Guidelines on Base Rate are as follows:

ü        All scheduled commercial banks should switch over from the existing BPLR system to the new Base Rate System

ü        Base Rate System is to be implemented from July 1, 2010

ü        Banks may choose any benchmark to arrive at the Base Rate for a specific tenor (tenure of the loan)

ü        Banks are free to use any other methodology, provided it is made available for RBI’s scrutiny

ü        All loans and advances should be linked to Base Rate. But, there are a few exceptions meaning the following loans can be disbursed without linking them to Base Rate:

                                i.            DRI advances

                              ii.            Loans to banks’ own employees

                            iii.            Loans to banks’ depositors against their own deposits

            Effectively, it means banks can lend below Base Rate in the above cases.

ü        Actual lending rate will be based on Base Rate plus customer specific charges

ü        Until the new system stabilizes, banks are given flexibility to change the benchmark and methodology any time between July and December 2010

ü        Base Rate can be used as a reference rate for floating rate loans

ü        The current stipulation of BPLR as the ceiling rate for loans up to Rs. 2 lakh, under priority sector and others, stands withdrawn wef July 1, 2010

ü        RBI will separately announce lending rates for export credit (The details are given elsewhere)

ü        Banks have to review Base Rate on a quarterly basis

ü        The Base Rate system will be applicable to new loans as well as loans that have come up for renewal

ü        Banks shall exhibit the information on Base Rate on their websites and at all their branches

The RBI’s circular on final guidelines is a watered-down version of the Deepak Mohanty Committee’s recommendations. The following table will help the reader.

Deepak Mohanty Committee recommendations	RBI's Final Guidelines (RBI circular dated April 9, 2010)
Base Rate should not be linked to the following loans, namely, (i). loans to	RBI has not granted any exception to these two types of loans
selective credit control and,
(ii). credit card receivables
Base Rate should be applicable to loans	No such stipulation by RBI
with maturity of more than one year
For loans below maturity of one year, banks	No such stipulation by RBI
are free to charge rates without any link to
Base Rate
Interest rates on export credit should not	RBI has stated that export credit should be
exceed Base Rate	at or above Base Rate
Educational loans should be administered	No such special treatment to Educational
& their rates should not exceed Base Rate	loans
plus 200 basis points
Base Rate should be calculated based on	Base Rate should be calculated based on
one year deposit rate adjusted for CASA	cost of deposits/funds and other criteria.
deposits and other criteria

As can be seen from the above table, RBI has accepted the Committee’s recommendations only partially. For calculating the Base Rate, RBI has given greater flexibility to banks with regard to selecting a benchmark and calculation methodology.

5. How is Base Rate different from BPLR?

Under the existing Benchmark Prime Lending Rate (BPLR), banks can give loans below BPLR, called sub-BPLR lending. In fact, as at the end of March 2009, 67 per cent of total loans in the entire banking system were contracted at below BPLR. This is not possible under the new Base Rate System. Banks are not allowed to lend at below Base Rate. It is the minimum lending rate banks have to charge to their customers. However, there are a few exceptions to this rule (the details are given elsewhere).

6. How is Base Rate calculated?

Banks are given freedom to decide their own Base Rates based on cost of deposits, adjustment for CRR/SLR maintenance, unallocatable overhead costs and average return on net worth.

According to RBI, Base Rate shall include all those elements of the lending rates that are common across all categories of borrowers. Banks may choose any benchmark to arrive at the Base Rate for a specific tenor to be disclosed transparently. An RBI illustration, for computing the Base Rate is given below:

BASE RATE

=

Cost of deposits/funds

+

Negative carry on CRR/SLR

+

Unallocatable overhead cost

+

Average return on net worth

Banks are free to use any other appropriate methodology, provided it is consistent and is made available for RBI review/scrutiny.

Strictly speaking, the above is only for illustrative purposes. RBI has given freedom to banks to use their own methods for the calculation of Base Rate.

(The above terms are explained with formulas in Annexure II at the end.)

7. Will customers be able get loans at Base Rate?

RBI says that banks can calculate the actual lending rate by adding customer specific charges to the Base Rate.

Frankly speaking, Base Rate is not equal to lending rate that will be charged ultimately to the customer. While arriving at the actual lending rate, banks will add certain appropriate charges specific to the customer, like overhead costs, credit risk premium and tenor premium. As per the Deepak Mohanty Committee’s report, actual lending rate can be arrived at as follows:

Actual lending rate *

=

Base Rate

+

Product specific operating cost

+

Credit risk premium

+

Tenor premium

* Actual lending rate that will be charged by banks to the borrowers

Credit risk premium: All loans carry credit risk meaning that the borrower may fail to repay the loan. The extent of credit risk differs from one borrower to another borrower depending on the borrower’s overall credit standing and other factors. So, the credit risk premium may be lower for a customer with good track record and may be higher for customers with not-so-good record.

Tenor premium: In general, the longer the maturity of the loan, the higher the risk for a lender. As such, banks usually charge higher rates for long-term loans compared to short-term loans, other things being equal.

Example: As all loans will be linked to Base Rate, whenever a bank changes its Base Rate, the loan rates of customers will change accordingly. Suppose Bank Efficient has kept its Base Rate at 8 per cent. And the Bank Efficient has fixed car loans at Base Rate plus 4 per cent (ie, 400 basis points), the car loan rate will be 12 per cent (8 + 4). After a few months, Bank Efficient has revised the Base Rate to 9 per cent, the car loan rate will be revised to 13 per cent (Base Rate plus car loan premium = 9 + 4). Moreover, the Bank has got freedom to revise the car loan premium. Depending on the market conditions and other considerations, the Bank may decide to increase the loan premium to 5 per cent from 4 per cent. Then, the car loan rate will be revised to 14 per cent (9 + 5).

8. What is transparency in loan pricing?

Transparency in bank lending means that banks should be able to provide adequate information to borrowers so that the latter fully understand the terms and conditions. Higher levels of transparency can be achieved by disclosing information on how the loan rates are arrived at by the bank. Transparent lending is equal to borrowers correctly understanding the loan pricing mechanism and other fees before signing the loan agreement. Banks should not indulge in charging any hidden costs and unexpected rate increases. To achieve greater levels of transparency, banks shall ensure that all charges and possibility of rate increases are made clear to the borrower at the beginning of the agreement.

Given the large proportion of sub-BPLR lending by the banking system, concerns have been raised on the transparency aspect of computation of BPLRs by banks.

9. What is monetary policy transmission?

Whenever RBI raises or lowers policy rates, banks are expected to revise their interest rates in tune with the RBI. The intentions of RBI will be carried through the commercial banks to the entire economy. Banks pass on the RBI’s policy measures either by increasing the lending and deposit rates or by lowering them in tune with the RBI’s policy measures. This is called Monetary Policy transmission. But, this monetary transmission is not happening in actual practice due to a variety of reasons. Banks usually respond with a considerable time lag to the changes in RBI’s policy rates. Whenever RBI raises policy rates, it is observed that banks raise their lending rates immediately. However, when RBI lowers policy rates, banks act slowly and lower their loan rates with a substantial time lag. Such downward stickiness in rates is creating problems for RBI in its objectives of achieving price stability and growth.

Monetary policy transmission is the responsiveness of the banking system to the changes in the monetary policy of the RBI. RBI raises policy rates and reserve ratios or decreases them depending on the macro economic conditions, inflation rate, government policies and others.

10. What type of customers can get loans at below Base Rate?

As stated above, there are a few exceptions to Base Rate rule which forbids banks from lending below Base Rate. In the following cases, RBI has permitted banks to fix rates without linking them to Base Rate:

1. Loans under the DRI scheme
2. Loans to banks’ own employees
3. Loans to banks’ depositors against their own deposits

11. What will be the advantages of Base Rate System?

v     RBI has decided to replace the BPLR with Base Rate to make credit pricing more transparent

v     It is expected that higher transparency will benefit all kinds of borrowers irrespective of the size of the loan

v     The Base Rate system is aimed at enhancing transparency in lending rates of banks and enabling better assessment of transmission of monetary policy

12. What will be the impact of the new method?

The biggest impact is that the new Base Rates from commercial banks will be much lower than the existing Benchmark Prime Lending Rates (BPLR). Due to heavy competition in the industry, some aggressive banks, whose cost of deposits/funds is lower compared to industry levels, may peg their Base Rates very low.

The new Base Rate System (BRS) is expected to impact the banks in different ways depending on their cost of deposits, overhead cost, their customer profile, geographical concentration and others. Likewise, the BRS will impact the debtors in various ways.

One biggest benefit with the BRS as cited by policymakers and experts is that it will help the Reserve Bank of India to transmit the changes in policy rates (Repo and Reverse Repo under LAF) in a better manner. Under the BPLR, monetary policy transmission is weak due to lack of transparency in BPLR. This has been brought out elaborately by Deepak Mohanty Committee’s Report. Now, with the BRS, RBI expects that banks will respond immediately to RBI’s policy rates.

  

Let me try to briefly examine the impact of BRS:

Ø     The Base Rate System is expected to usher in a transparent system meaning borrowers will be able to understand how their loan rate is arrived at

Ø      After the implementation of Base Rate, banks will stop fresh lending below their BPLRs as they shift to Base Rate System

Ø      Highly-rated companies have been borrowing at sub-BPLR rate for a long time due to competition among banks and this practice may come to an end after the Base Rate kicks in

Ø     Once BRS comes into effect, rates for short-term bank loans to corporates could rise. However, large and reputed companies with strong balance sheets may explore Commercial Paper (CP) route. Hence, the BRS may not change loan rates for big companies, like, RIL, L&T, ONGC, as they have direct access to CP or bond markets.

Ø    Small and Medium Enterprises (SMEs) may get favourable rates. The impression in public that SMEs and small borrowers are subsidizing the corporate loans. This type of cross-subsidization will stop from now.

Ø   This is a step towards further deregulation of interest rates as banks will stop giving concessional rates to loans below Rs 2 lakh (especially priority sector loans up to Rs 2 lakh). RBI has given freedom to banks to charge commercial rates for loans below Rs 2 lakh at rates linked to base rate. With this, RBI wants to increase the credit flow to small borrowers.

It remains to be seen how the Base Rate will impact the credit offtake. As of now, credit growth is sluggish due to a variety of reasons. As banks will not be able to lend below Base Rate, corporates will turn toward Commercial Paper route and banks may not be able to lend their surplus funds in the short term. One piquant situation may be that borrowers with ‘AAA’ rating will approach the markets through the Commercial Paper (CP) route. Banks will invest in these CPs and such lending through CP route will not be part of their ‘Advances,’ but part of ‘Investments.’

Alternatively, banks may be tempted to park their surplus with the Reverse Repo window of the RBI’s LAF or invest in G-Secs or liquid schemes of mutual funds.

13. To what kinds of Banks the Base Rate is applicable?

The Base Rate is made applicable by RBI to all scheduled commercial banks (ASCBs) in India, except Regional Rural Banks (RRBs).

 14. Whether banks have fixed their Base Rates?

So far, no bank has fixed its Base Rate. Another two weeks time is available for banks to announce their Base Rates before the deadline of July 1^st. State Bank of India, India’s biggest lender, has indicated that it may link its Base Rate to cost of deposits and the Base Rate may be around eight per cent. Average cost of deposits for SBI is 5.80 per cent as on March 2010. And its cumulative net interest margin (NIM) is 2.66 per cent for the financial year 2009-10.

Union Bank of India has hinted that it may set the Base Rate between 8.25 and 8.75 per cent. According to rumours, it seems HDFC Bank is likely to fix its Base Rate at around six per cent. It may be noted that its Net Interest Margin has traditionally been much higher at around 4.0 per cent. In fact, for the year 2009-10, the net interest margin is 4.3 per cent for the bank. This is due to very low cost of deposits, which is at 4.7 per cent for 2009-10.

Overall, the Base Rate range may be between six and nine per cent for most of the commercial banks initially.

15. What is the lending rate for export credit?

In its circular dated April 9, 2010, RBI had stated that it would announce the rates for export credit separately. And as promised, RBI had issued a circular on April 23, 2010 stating that banks should fix their lending rate to export credit (both pre-shipment rupee export credit and post-shipment rupee export credit) at or above the Base Rate. The revised instructions will be effective from July 1, 2010.

16. Why is sub-BPLR rampant in the banking system?

Keeping in view the international practice and to provide further operational flexibility to commercial banks in deciding their lending rates, RBI in April 2001 decided to make PLR a benchmark rate. Accordingly, commercial banks were allowed to lend at sub-PLR rate for loans above Rs.2 lakh. In 2003, RBI replaced the PLR system with BPLR. In the beginning, it was expected that sub-BPLR lending would be marginal. But from 28 per cent of total bank credit in March 2002, sub-BPLR lending had gone up to 77 per cent in September 2008 before declining to 67 per cent in March 2009.

On account of competitive pressures, banks were lending a part of their portfolio at rates below their BPLRs. A large loan offered to a highly rated borrower may be offered at a lower rate below the current all-in-cost BPLR due to little risk and savings on account of processing and monitoring costs. Although justifiable to some extent, such sub-BPLR lending on a large scale has created a perception that large borrowers are being cross subsidized by retail and small borrowers.

(The timeline for the evolution of PLR/BPLR system is given in Annexure III.)

17. What is downward stickiness in rates:

The Working Group has observed that whenever RBI raises policy rates and reserve ratios, banks are quick to increase their loan rates. But, when RBI reduces policy rates and reserve ratios, banks respond very slowly effecting decreased lending rates with a considerable time lag. This is called downward stickiness in rates. RBI has opined that this downward stickiness is adversely impacting the monetary transmission mechanism in the banking system.

One of the major reasons for downward stickiness is the large share of deposits (major portion consists of term deposits with fixed tenure) contracted at high rates in the past. In response to RBI’s reduction of policy rates, banks are not in a position to reduce their lending rates as their cost of funds will remain high for quite some time during the early part of a declining interest rate environment. The marginal cost of funds is more relevant for banks for pricing current loans/advances rather than the average cost which is computed on the basis of the cost of all outstanding purchased and borrowed liabilities reflected in the balance sheet.

The downward stickiness in BPLRs is also attributed to several other factors such as (i) the administered interest rate structure on small savings, which constrains the reduction in deposit rates; (ii) concessional lending rates linked to BPLRs for some sectors, which make overall lending rates less flexible; and (iii) persistence of the large market borrowing programme of the government, which hardens interest rate expectations.

18. What is the criticism of the Base Rate System?

The new Base Rate System has received more brickbats than bouquets from several industry watchers:

• U.R.Bhat, Dalton Capital Advisors: “The prohibition from lending below the base rate virtually bids goodbye to the principles of free market…Banks may need to lend short-term to low-risk borrowers at rates below the Base Rate depending on the market conditions…” (Economic Times, March 8, 2010).

• Saurabh Mukherjea, Noble Group: “Seventy per cent of the Indian banking system is in the hands of public sector banks. These banks’ profits will come under pressure as the interest rate cycle moves north…Hence, by diminishing the intensity of competition in the banking sector, RBI is taking care of the interests of public sector titans like the State Bank of India and Punjab National Bank…” (Outlook Profit, 2^nd April 2010)

19. CONCLUDING REMARKS

The Base Rate System is only starting from July 1, 2010. The RBI has given a cooling period of six months till December 31, 2010, which gives banks flexibility to experiment with various calculation methods and Base Rates, before settling for a particular method or a specific Base Rate. As such, the system will evolve over a period of time.

We can definitely expect some more changes to the Base Rate System once RBI gets a feel of the new system. Banks have been smart players and they have been making good profits notwithstanding the global financial meltdown of 2008 and the wild movements in interest rates.

It is expected that banks will be able to protect their margins despite the Base Rate System, unless more banking licenses are given by RBI/Government. India’s Telecom Sector has witnessed intense competition in the last two to three years and this has benefited the customers immensely due to steep reduction in telephone tariffs. The competition in Telecom Sector has widened the market base and this has brought higher revenues for the Government in the form of service tax, corporate tax and income tax.

Can we expect that the same thing will happen in the banking sector?

It may not happen in banking sector until more banking licenses have been issued to both the private sector and public sector players. In this backdrop, it remains to be seen whether the twin objectives of RBI of bringing in better transparency and improved monetary policy transmission will be achieved.

Moreover, it will be interesting to watch the response of the market, banks, stakeholders, RBI and the Government to this new development.

  

ANNEXURE I

REPORT OF THE WORKING GROUP ON

BENCHMARK PRIME LENDING RATE HEADED BY DEEPAK MOHANTY

The Working Group had the following terms of reference:

            (i) to review the concept of BPLR and the manner of its computation;

            (ii) to examine the extent of sub-BPLR lending and the reasons thereof;

            (iii) to suggest an appropriate loan pricing system for banks based on           

                  international best practices.

The Committee’s observations and recommendations:

1. The concept of BPLR is outdated and is out of sync with the present market conditions
2. BPLR system is not very effective in achieving the objectives of RBI in terms of monetary policy transmission
3. BPLR system lacks transparency
4. Due to distortions in the BPLR, banks were lending at rates much below the BPLR thus defeating principles of commercial judgment
5. A new system called BASE RATE should be introduced replacing the existing BPLR
6. Base Rate would be based on the following:

                                                              i.            The card interest rate on retail deposits (deposits below Rs 15 lakh) of maturity of up to one year (adjusted for CASA deposits)

                                                            ii.            Loss incurred by banks for maintenance of CRR and SLR

                                                          iii.            Overhead cost of banks

                                                          iv.            Average return on net worth

7. The actual rate charged to borrowers would be Base Rate increased by operating costs, credit risk premium, tenor premium and others
8. Banks should not lend at rates below the Base Rate
9. However, the following exceptions may be given to the above rule, meaning, banks can charge interest rates below the Base Rate for the following types of loans:

                                                               i.            Loans pertaining to selective credit control

                                                            ii.            Credit card receivables

                                                          iii.            Loans to own employees

                                                          iv.            DRI loans

10. Base Rate System would be applicable for loans with maturity of one year and above (including working capital loans)
11. Banks may give loans for periods of less than one year at fixed or floating rates without reference to Base Rate subject to certain conditions. In this regard, the Committee has recommended certain ceilings for such sub-Base Rate lending.
12. Base rate shall be the basis for floating rate loans also. Banks may use Base Rate or any external market-based benchmark rates (like, G-Sec, Repo rate, MIBOR, CP, CD etc).
13. At present, the Government administers loans of up to Rs 2 lakh to small borrowers, under priority sector and others. This administered regime shall be discontinued and these loans can be brought under the Base Rate system.
14. Interest rate on rupee export credit should not exceed Base Rate
15. Educational loans should be given a special exemption and they should continue to be administered. Interest rate on educational loans should not exceed Base Rate plus 200 basis points.
16. Banks should pass on the information about Base Rates to the public through their websites

ANNEXURE II

Mathematically, the Base Rate is calculated as follows as per RBI’s illustration:

Base Rate = a + b + c + d

a = cost of deposits/funds = CoD

b = Negative carry on CRR and SLR

 

       [ CoD – (SLR x Tr)]

   =  ----------------------- x 100       –      CoD

       [1 – (CRR + SLR)]

           

                                                              Uc

c = Unallocatable overhead cost = ------ x 100

                                                              Dply

                                                                                   NP           NW                                                                                      

d = Average return on net worth = ------ X ------ x 100

                                                              NW      Dply

Where,

D = Total Deposits = Term deposits + Current a/c deposits + Savings deposits

Dply = Deployable deposits

      = Total deposits less share of deposits locked in SLR and CRR

      = D x [1 – (CRR + SLR)]

CRR = Cash Reserve Ratio

SLR = Statutory Liquidity Ratio

Tr = 364-day Treasury Bill rate

Uc = Unallocatable overhead cost

NP = Net profit

NW = Net worth = Capital + free reserves

Negative carry on SLR and CRR: At present, SLR is 25 per cent and CRR is 6 per cent. CRR balance does not provide any return to banks; while the return on SLR balance is lower than the cost of deposits. As such, SLR and CRR carry negative returns for banks.

Unallocatable Overhead Cost: It is fixed overhead cost consisting of Head Office and Corporate Office costs, which cannot be allocated. Examples of such overhead costs are: aggregate employee compensation relating to administrative functions in corporate office, directors’ and auditors’ fees, legal and premises expenses, depreciation, cost of printing and stationery, expenses incurred on communication and advertising and IT spending, etc.

  

ANNEXURE III

Evolution of BPLR in India : A Snapshot

Early 1990s

Till the early 1990s, deposit and lending rates were mostly administered by RBI. In the early 1990s, RBI started deregulating deposit rates and lending rates.

October 1994

Lending rates for loans with credit limits of over Rs. 2 lakh deregulated. Banks were required to declare their Prime lending rates (PLRs).

February 1997

Banks allowed to prescribe separate PLRs and spreads over PLRs, both for loan and cash credit components.

October 1997

For term loans of 3 years and above, separate Prime Term Lending Rates (PTLRs) were required to be announced by banks.

April 1998

PLR converted as a ceiling rate on loans up to Rs.2 lakh.

April 99

Tenor-linked Prime Lending Rates (TPLRs) introduced.

October 1999

Banks were given flexibility to charge interest rates without reference to the PLR in respect of certain categories of loans/credit.

April 2000

Banks allowed to charge fixed/floating rate on their lending for credit limit of over Rs.2 lakh.

April 2001

The PLR ceased to be the floor rate for loans above Rs. 2 lakh. Commercial banks allowed to lend at sub-PLR rate for loans above Rs.2 lakh.

April 2002

A system of collection of additional information from banks on the (a) maximum and minimum interest rates on advances charged by the banks; and (b) range of interest rates with large value of business and disseminating through the Reserve Bank’s website was introduced.

April 2003

In place of PLR, RBI announced introduction of a new system called Benchmark Prime Lending Rate (BPLR). The Reserve Bank advised banks to announce a BPLR with the approval of their boards. The BPLR was seen as a reference rate and was to be computed taking into consideration (i) cost of funds; (ii) operational expenses; and (iii) a minimum margin to cover regulatory requirements of provisioning and capital charge, and profit margin. The system of tenor-linked PLR discontinued.

ANNEXURE IV

SOME TERMS DEFINED:

Floor Rate                  : It is the rate below which a bank cannot lend

Reference Rate         : It is the rate which is used by banks as a benchmark for arriving                                         at the lending rate. Usually, lending rates are linked to the                                              reference rate. LIBOR (London Inter-bank Offered Rate) is                                          considered a reference rate for a majority of foreign currency                                                   loans available abroad.

PLR                             : Prime Lending Rate was traditionally the lowest rate charged to                                          the prime borrowers with highest credit rating

BPLR                          : The Benchmark Prime Lending Rate was seen as a reference                                            rate and was to be computed taking into consideration (i) cost of                                           funds; (ii) operational expenses; and (iii) a minimum margin to                                             cover regulatory requirements of provisioning and capital charge,                               and profit margin.

Policy Rates              : Repo & Reverse Repo Rates & Bank Rate are RBI’s policy rates   

Reserve Ratios          : SLR and CRR are the reserve ratios of RBI

SOURCES:

RBI website

Deepak Mohanty Committee’s Report of the Working Group on study of BPLR

Economic Times, Business Line, Outlook Profit, etc.

DISCLAIMER: The views are personal. The views need not be construed as those of the organisation which the author represents. He blogs at: 

http://ramakrishnavadlamudi.blogspot.in/

http://www.scribd.com/vrk100

	THE BEST OF MY STUFF ON	Reads
	http://www.scribd.com/vrk100
	1.    Goods and Services Tax-GST-an introduction		6 349
	2.    Currency Futures in India - an update		3 270
	3.    India Budget 2010-11 and its impact on  individuals		2 782
	4.     Income Tax Slabs 2010-11 - Individuals, salaried class		2 618
	5.    Direct Taxes Code Bill 2009-Impact on individuals		2 541
	6.    Public Provident Fund PPF A/C - Little Known Facts		2 284
	TOTAL READS  running towards  77,000!
	From A Total of 100 Documents in about 10 months

Other Popular documents of the author include:

IFRS – A Guidebook on International Financial Reporting Standards

Greece Debt Crisis – A Greek Tragedy amid double-dip recession fears

Oil Subsidy Burden – Kirit Parikh Committee recommendations analysed

Best Tax Saving Mutual Funds

Government Securities Market in India & Bond Duration Management

Nifty BeES – An Exchange Traded Fund explained

What is Sensex and its importance in the Indian Stock Market

Interest Rate Futures introduced in India

Commodities Trading in India – A Guidebook

Junior NiftyBeES – How to make higher profits

European Central Bank-ECB-Its Key Policy Rates decoded