The Reserve Bank of India (RBI) today proposed to replace the current system of benchmark prime lending rate (PLR) from next fiscal with a base rate below which no banks can advance commercial loans.
"The base rate system will replace the PLR system with effect from April 1...Since the base rate will be the minimum rate for all commercial loans, banks are not permitted to resort to any lending below the base rate," RBI said in its draft guidelines on the base rate.
Accordingly, the current requirement that PLR will be the ceiling rate for loans up to Rs 2 lakh will stand withdrawn, the central bank said in its draft guidelines.
The proposed base rate will be applicable to all new loans as well as existing loans which come up for renewal. Existing borrowers are free to switch to new system, the RBI said.
The central bank sought opinion from stakeholders on these norms by February 17.
The PLR system has been drawing flak from various quarters since banks have been lending to highly-rated corporates below their benchmark rate, making the system irrelevant.
Each bank may decide its own base rate on the basis of cost of deposits, adjustments in respect of RBI's mandatory cash requirements, profit margins, among others.
The actual lending rates of banks would be the base rate plus the borrower-specific charges like premium related to maturity of loans, the draft paper said, adding "all categories of loans henceforth be priced only with reference to the base rate."
The RBI draft note said the proposed base rate could also serve as the benchmark rate for floating rate loans apart from other external market benchmark rates. As such, floating interest rates based on external benchmarks should, however, be equal to or above the base rate during sanction or renewal.
Since banks were resorting to sub-PLR lending, RBI was finding it difficult to transmit the changes made in the monetary policies because of non-transparent nature of fixing lending rates. Therefore, the RBI has asked all banks to ensure transparency in fixing base rates. Banks will also be asked to ensure that customers are not discriminated against in terms of interest rates, according to the draft norms.
The central bank said as there would be no ceiling for loans, credit flow to small borrowers at reasonable rates would increase. "It is expected that deregulation of lending rates will increase the lending to small borrowers at reasonable rate," it said.
As such, the RBI said direct bank finance will provide effective competition to other forms of high cost credit.
However, the central bank spared the differential rate of interest (DRI) scheme, which provides loans to low income groups at concessional rate of interest, from the new guidelines. The central bank will separately come out with norms for export credit.
The RBI had constituted a working group on PLR and the report of the group was placed on the apex bank's website on October 20, 2009 for public comments.
After considering the group's recommendations and the suggestions received from various stakeholders, RBI came out with the draft circular on the proposed changes in the present lending rate system today.
