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New method for banks to calculate base rate?

business Updated: Sep 30, 2015 01:37 IST
Hindustan Times
Reserve Bank of India

(AFP FIle Photo)

When the Reserve Bank of India (RBI) said in its monetary policy statement that the central bank would work with the government to create conditions to ensure that banks pass on interest rate cuts faster, governor Raghuram Rajan had in mind a number of innovative proposals, including a change in the way the base rate is calculated by banks.

“…the focus of monetary action for the near term will shift to working with the government to ensure that impediments to banks passing on the bulk of the cumulative 125 basis points cut in the policy rate are removed,” said the RBI statement. Banks have so far cut rates only by 0.30 percentage points. State Bank of India, however, reduced its base rate by 0.40 percentage points on Tuesday after RBI’s policy statement.

In response to a question by HT, Rajan said the RBI would consider different measures. “One is looking at how banks calculate the base rate. We are urging them to move to a calculation that is more responsive to the policy rate as well as to other interest rates available in the market. That is what we call a movement to marginal cost pricing rather than average cost pricing,” he added.

The base rate or minimum lending rate was introduced by the RBI in 2010 after the erstwhile Benchmark Prime Lending Rate failed to respond to monetary policy changes. While the RBI allowed banks to use any method to calculate base rates, the popular option was the average cost pricing. The base rate is typically loaded with extra charges such as the risk premium — depending on the category a borrower falls into — to arrive at the final rate which is levied on the consumer.

The marginal cost, as suggested by Rajan, is calculated based on the interest rate payable on current and savings deposits and term deposits of various maturities. The average cost on the other hand is less practical as it masks the policy rate changes on longer-tenure deposits.

“We have also put out some regulations on that (the base rate calculation) for comments and we will take cognizance of the responses that we get and form a final set of regulations,” he said. “Liquidity cannot be the reason that banks can’t pass on (rate cuts),” he added.

The small savings rate is another area. The government has been looking at this with the idea of bringing them more in line with the market. “The idea is not to cut them to hurt the small saver but to bring them in line with the industry so that it doesn’t become a distortion,” Rajan said. Analyst estimates suggest that banks could get about Rs 30,000-40,000 crore through the small savings route.