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.
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).
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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