Simplifying the recent Pro-Customer RBI notifications

Updated on January 30, 20155 mins read

There have been two important notifications (enlisted below) by the Reserve Bank of India (RBI) on Display of Information and Calculation of Base Rates and Spreads that are customer-friendly and aim to:

  • Increase the transparency of banks in their operations
  • Reduce the discretionary pricing powers of the banks

In this article I aim to not only explain in detail the various aspects of the notifications but also their intended impacts.

I Display of information by banks : notified on January 22, 2015

Based on the recommendations of the Working Group on Pricing of Credit, from April 1, 2015, banks must ensure that:

a) Their Website provides the following information with respect to individual borrowers:

  • different types of advances given in the last quarter with the interest rate range and the mean interest rates for each type
  • the total fees and charges applicable on various types of loans*
  • Annual Percentage Rate (APR) or a similar concept indicating the total cost of credit on a loan

*This information should also be disclosed at the time of processing of loan.

b) The Key Statement or a Fact Sheet as per prescribed format (with important Loan Information like Loan Amount, Term, Interest Rates etc.) should be provided clearly to the individual borrowers:

  • at every stage of the loan processing
  • in case of any change in any terms and conditions.
  • as a summary box displayed in the credit agreement**

**optional

Likely impact of this notification:

In this notification RBI requires the banks to be more transparent with regards to interest rates. This shall enable customers to

  • compare similar products across banks
  • make informed decisions

II Interest Rates on Advances: notified on January 19, 2015

RBI issued additional guidelines to banks regarding Calculation of Base Rates and Spreads which shall be effective from February 19, 2015:

a) Computation of Base Rate

The change made in this notification as compared to the earlier guidelines issued in 2010 is that:

For the computation of ‘cost of deposit’, the interest rate on a particular tenure of the deposit should be the one which has the largest deposit base. There is no other change in the computation methodology or benchmark to be used.

Let’s understand this better:

RBI does not prescribe any methodology for computation of Base Rate. It merely gives an illustration and states that “While computing Base Rate, banks will have the freedom to calculate cost of funds either on the basis of ‘average cost of funds’ or on ‘marginal cost of funds’ or any other methodology in vogue, which is reasonable and transparent provided it is consistent and made available for supervisory review/scrutiny as and when required.”  ‘The cost of deposit’ is an important input in the base rate formula and banks can use the average rate of interest for the previous quarter as a benchmark rate of interest. Some banks have chosen the rate for a particular bucket like 90 days to 180 days.

Likely impact of this change:

If a bank chooses ‘average cost of a deposit’ while calculating its Base Rate, probably this notification of RBI shall have no impact. But for those banks who had taken applicable rate of interest for a particular bucket where the deposits are a small share of the total volume of deposit, this notification will affect them. It is possible that banks which were targeting low base deposit rates may shift to average rates. This could result in customers getting a more ‘fair’ rate.

b) Review of Base Rate

  There is no change in this notification with regards to this aspect.

“As hitherto, banks are required to review the Base Rate at least once in a quarter with the approval of the Board or the Asset Liability Management Committee (ALCO) as per the bank’s practice.”

c) Review of Base Rate methodology

The basic difference between earlier guidelines and the current guidelines on the review of the Base Rate Methodology is:

 “With a view to providing banks greater operational flexibility, it has been decided to allow banks to review the Base Rate methodology after three years from date of its finalization instead of the current periodicity of five years. Accordingly, banks may change their Base Rate methodology after completion of prescribed period with the approval of their Board of Directors/ ALCO.”

Likely Impact of this change:

Most banks had set their Base Rate formula last in 2010 (three years back), at the time of the last notification by RBI in this regard. Hence, they will relook at the various components and the computation methodology soon.  The decision to set the Base Rate is taken by each bank’s Asset Liability Committee (ALCO).

d) Spreads

RBI asks the banks to follow the below mentioned guidelines with regards to Spreads:

(i) Banks should have a Board approved policy for spreads which shall determine price differentiation which should have the following aspects:

  • components of spread
  • rationale for spread #
  • range of the spread in the case of a given category of borrower
  • delegation of powers in respect of loan pricing

 #should be available for Superior Review

 ii) Banks cannot change spread for an existing borrower except when##

  •  credit risk profile of the customer deteriorates, in which case it is supported by a full-fledged risk profile review of the customer
  • there is change in the tenor premium should not be borrower specific or loan class specific; it should be uniform for all types of loans for a given residual tenor;

 ##is not applicable for consortium/ multiple banking arrangements

 The likely impact of the guidelines on Spread:

  •  The banks’ discretionary power in pricing shall be kept in check.
  • The addition of the ‘tenure premium’ in the Spread may make banks revisit the base rate. The reason is that most banks have been giving home loans at the base rate particularly for affordable housing loans. With the requirement of RBI that the tenor premium should be uniform, the preferential rates for particular classes of loans like Home Loans and Auto Loans may stop.

Hope you have understood the rationale and impact of the recent RBI notifications as enlisted above. Do share your views and comments with us.

  Cheers to a healthy, financially-stable and comfortable life!

 


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