ery few retail borrowers know that the Reserve Bank of India (RBI) is working towards making the reference lending rate more transparent, which,
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in turn, will make it easier for them to comprehend the interest rate structure. The reference rate, popularly known as benchmark prime lending rate (BPLR), is the one on which banks peg interest rates for their customers.
Earlier, all loans, retail and corporate, were benchmarked to a bank’s PLR. Thus, the bank’s best-rated customers would get loans at the benchmark rate while the lower-rated clients had to pay a few basis points (a basis point is 0.01%) above the PLR. Consequently, there was enormous clarity on lending rates that customers paid to their bank.
Ironically, the entire matrix of loan pricing changed, around 2001, after RBI allowed banks to lend at rates below PLR. More and more corporates began demanding sub-PLR loans. This has currently reached a stage where nearly 72% of the total loans given by banks are below PLR.
Moreover, almost all bankers openly concede that PLR has lost its relevance as prime customers are offered loans at rates below the prime rate. Yet, banks insist on linking interest rates on all loans to their respective PLRs, which means that all loans are either a few basis points above or below them.
In such a scenario, while corporates get away with lower rates, retail customers invariably feel cheated. This is because lending below PLR allows banks to continuously make attractive loan offers to new customers without altering the benchmark rate.
As a consequence, old retail customers end up paying a higher rate compared with new clients. Over the past few days, many home loan providers including the State Bank of India and HDFC have announced attractive offers, but for new customers. For existing customers, interest rates have remained unchanged despite taking loans at floating rates of interest. Since the beginning of the current calendar year, banks and housing finance companies have reduced rates by 50-125 bps.
One of the most common reasons pointed out by bankers for the rate differential is a reduction in the incremental cost of funds. But, when the incremental cost of deposits comes down, the overall cost of funds also comes down. Since the benchmark lending rate is a function of cost of funds, if the overall cost of funds comes down, banks should reduce their PLRs, thereby passing on the benefits to old customers too.
The biggest grievance of old customers lies in the non-transmission of a soft rate regime to them despite them having taken home loans in floating rates. The interest rate differential between the old and new customer is anywhere between 150 and 200 basis points, and in certain cases even higher.
Bankers in India invariably justify their stand by saying that they have cut their PLRs and it would be wrong to suggest that the benefits of soft interest rates are not being passed on. However, old retail customers argue that given the difference in rates (between old and new clients), the full benefit of a soft rate regime is not being passed on to them.
Bankers maintain that ample liquidity and competition in the system have prompted them to offer attractive rates, which, in turn, will help them build a customer base. In fact, most bankers and home loan lenders do not even think that they have wronged their existing retail customers by charging them higher rates compared with those offered to new customers. RBI, on the other hand, appears quite insensitive to the matter.
Experts point out that the biggest flaw in the Indian banking system is the lack of a benchmark rate and the phenomenal dependence of banks on
sub-PLR lending. Lenders refuse to accept the yield on government securities as a benchmark rate while India’s debt market is too shallow for one to evolve.
As of now, banks will be able to get away with the difference in rates because smart customers are shifting from one bank to another to avail of the lower lending rate benefit. A factor to watch out for would be bankers’ reaction to a turn in the interest rate cycle. Would banks then refrain from hiking rates for old borrowers on the ground that their old cost of funds remains low and hike rates only for new customers because their incremental cost of funds becomes high?
One can only hope that suggestions by the RBI committee on BPLR forces banks to pass on the full benefit of soft interest to old retail customers. But the only problem that one can foresee is that by the time the report is out the interest rate cycle may have turned.
CAclubindia
