Loans by banks are linked to their base rates , below which they cannot lend. The loan rate is usually higher than base rate. Banks arrive at the base rate after looking at their cost of funds and other factors. That is why is base rate different for each bank. Why do banks charge existing customers more than their rate for new customers? Is it a way to fleece customers who they think are stuck with them? We answer the questions on base rate in this article.

What is the base rate?

A base rate is the minimum rate of interest that a bank is allowed to charge from its customers. Unless mandated by the government, RBI rule stipulates that no bank can offer loans at a rate lower than the base rate to any of its customers.  Base Rate includes is common across all categories of borrowers.

 A lending rate is the rate at which banks lend to their customers, it is base rate plus a margin or spread, for example, base rate plus 50 basis points or bps.. The actual lending rates charged to borrowers would be the base rate plus borrower-specific charges, called as the spread or the margin, which include product-specific operating costs, credit risk premium and tenor premium. So, it differs across various segments.

For example from State Bank of India website Base rate and spreads are given below.  Borrowers of loan upto 30 lakh will pay 10.10% p.a interest, of which 9.8% is the base rate and 0.3% is the spread or margin

 Base Rate:  9.80% (w.e.f.  19/09/2013)

Are there any exemptions for the granting loans below Base Rate?

Yes, there are exemptions such as Differential Rate of Interest Scheme(DRI) advances, loans to banks employees as per the HR Policy and loan against own deposits held with the Bank and any other category of loan (ex agricultural)  or advances mentioned by RBI from time to time.

Who fixes Base Rate ?

Reserve Bank of India (RBI) does NOT  fix the base rate.  It has issued broad guidelines to bank as to how they should arrive at the base rate.  Thus, individual bank itself fixes its own base rate.

How does a bank decide its base rate?

Each bank decides its own Base Rate. A host of factors, like the cost of deposits, administrative costs, a bank’s profitability in the previous financial year and a few other parameters, with stipulated weights, are considered while calculating a base rate. For details on how bank calculates base rate one can read RBI guidelines on Base rate.

How often the Base Rate will be changed by Banks ? 

Banks are required to review the base rate at least once every quarter.   Banks can review the same even more than once a quarter.  After review, the Bank may decide to change or continue the same base rate. Change of base rates of State Bank of India and HDFC Bank are given below

Why do banks charge existing customers more than their rate for new customers? Is it a way to ‘fleece’ customers who they think are stuck with them?

The base rate may change but the bank do not alter the spread or the margin at which it has offered loans to existing customers. So considering a spread of 50 bps, if the base rate comes down from 10% to 9.75%, the interest rate for existing customers will fall from 10.5% to 10.25%.

However, banks can offer new loans at a higher or lower margin, say, base rate plus 25 bps. So, for a new customer, the rate will be 10% (base rate at 9.75%), while old customers will continue to pay 10.25%. Existing borrowers feel cheated by such a difference in rates.

How to deal with differential rates ?

There are two ways to deal with the problem of differential rates.

• One, you can switch the loan to a bank offering a lower rate. This is easy now as pre-payment penalty on floating rate loans has been abolished. The new bank will charge only a processing fee of 0.5-1% of the outstanding loan. Some banks may even waive the fee if you bargain hard.
• Another option is switching to the lower rate being offered to new customers by paying a small fee. Most banks offer this facility to retain customers.

The base rate system replaced the Benchmark Prime lending rate (BPLR) system, which was the methodology earlier followed by the banks since 2003. The BPLR varied from Bank to Bank and the variation was quite wide, stretching over 4% sometimes. While initiating the move to replace the existing system of BPLR, RBI felt that the The calculations of BPLR was mostly NOT transparent  and BPLR lending rate system hindered effective transmission of monetary policy signals.  For example, when the years 2008 and 2009, RBI reduced its its benchmark lending rate by 425 basis points banks reduced their BPLR by about 200 basis point .  This was mainly because bulk of their lending was below their BPLR. Although, BPLR of Indian banks ranged between 11 percent and 15.75 percent,  yet three-fourths of their total loans were made below these levels because of competitive pressures in the fragmented banking sector. The base rate makes pricing more transparent as  base rate has to be disclosed publicly and banks are not permitted to lend below base rate.

Why Banks are still continuing with BPLR whereas Base Rate has been made Applicable?

Although RBI has introduced Base Rate as a reference benchmark rate for all floating rate loan products with effect from (wef) 1st July, 2010, yet  RBI has  allowed banks to continue BPLR but only on the loans which have been sanctioned before the introduction of  Base Rate i.e. July 2010 until maturity  These borrowers have the option of approaching the bank to switch to the base rate system before the expiry of their loans.

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