Base rate is the minimum rate at which a commercial bank in India is allowed to offer a loan to a borrower, as per RBI guidelines. This along with the credit risk premium decides the cost of the loan. All commercial banks in India have the freedom to decide their respective base rates as per the duration of the loan, considering rules and regulations framed by the RBI. While a bank has the autonomy to zero upon a minimum lending rate, no bank can offer a loan that is lower than this benchmark interest rate i.e., base rate.
Now that you know the base rate definition, let us see how it came into effect. The RBI introduced the base rate as the standardized rate of lending for all banks in India on July 1, 2010. Loans that were approved as well as those up for renewal after this date could be switched to the new base rate system. However, banks also had the option to continue with the Benchmark Prime Lending Rate (BPLR) for loans taken by borrowers before July 1, 2010.
As you can see from the base rate meaning itself, it was a measure taken by the RBI for increased transparency, clarity and removal of disparity in the lending process. The BPLR system that was operational before the introduction of the base rate had led to non-uniform lending rates by banks. This is because under the BPLR system banks could fix the rate of interest in consultation with their boards.
However, there were no restrictions on lending at a rate below the BPLR which led to inconsistencies in different loan rates. For instance, while low-risk customers such as corporates were offered loans at a rate below the BPLR, salaried and other individuals had to pay the usual lending rate. Removal of BPLR and adherence to base rate definition has brought about a reform in the banking system by setting a standard for the rate of lending without bias. The benefits have been directly transferred to you, the borrower who is no longer in the dark about the interest policy of a bank when you apply for a loan.
BPLR system allowed banks the flexibility to offer varying interest rates to their customers. The rate at which a bank was interested to lend money to its different customers was defined as the Benchmark Prime Lending Rate. There was no standardisation in the process and hence lack of transparency on how a bank arrived at BPLR for a borrower.
However, the base rate definition establishes it as the threshold interest rate as mandated by the RBI below which a borrower cannot be provided with a loan. Clarity in base rate meaning has brought in more objectivity to the lending process by standardizing the lending rate across all authorized financial institutions. This has helped to do away with favouritism during loan approval process with individuals from all financial backgrounds having access to a fixed and transparent interest rate when applying for a loan.
After knowing in detail what is the base rate and how it came into effect, it is time to move on to how it is calculated. As you know already, each bank has a unique base rate that it arrives at in line with the RBI regulations. Computation is done based on lending rate factors that are common to all lender categories such as:
Fund cost or rate of interest of the deposit
Minimum profit rate
CRR (Cash reserve Ratio) cost
Among all the above, the cost of deposits holds the most value in the base rate calculation and a bank may take a call on which loan’s cost of deposit it would want to consider to compute the base rate.
Since April 1, 2016, all Indian banks have started following the Marginal Cost of Funds based lending system which uses the MCLR method to calculate the base rate. This method is more dynamic since banks are required to update MCLR every month. Here are a few components used in the calculation of MCLR:
Cost of operation
Marginal cost of funds
Negative CRR carry on amount
This methodology makes use of the marginal cost to compute the cost of the funds. The marginal cost is in turn calculated by using the bank repo rate and other additional costs involved in fund acquisition.
According to the base rate meaning, it has been established as a benchmark value, which means you can be assured of getting a loan at a fair interest rate when you apply for one. It has also helped to remove the complexity of arriving at a lending rate and transferred the benefits to the customers by doing away with the profits accrued to financial institutions. The base rate system is simpler, fairer and more economical. All you have to do when you apply for a loan is to take a look at the interest rate offered by a bank according to its base rate. Compare the lending rates across financial institutions and choose a loan option, that meets your needs
Knowing what is the base rate can help you to make an informed decision when choosing a loan. However, apart from the interest rate, you also need to compare loans at several other parameters before you zero in on one that suits your requirements. If you are looking for a Personal Loan at competitive interest rates, you should consider those available on Finserv MARKETS.
You can avail a personal loan amount of up to Rs. 25 Lakhs, with repayment tenures ranging from 12 months to 5 years, at Finserv MARKETS. Not only this, you can repay the loan amount before the tenure at minimal charges. Isn’t that great?