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Is the base rate transparent? 
(Tue, 10 Jul Pre-Open) 
 
Two years back, Reserve Bank of India (RBI) replaced the traditional benchmark prime lending rate (BPLR) mechanism with base rate. This was to ensure more transparency while lending. BPLR was the rate that was offered to a borrower with a strong credit history. However, due to increasing competition banks started discriminating amongst customers. Corporates were given money at subsidized rates while retail customers were charged higher interest rates.

As a result, RBI decided to replace BPLR with base rate. But now the banking regulator has expressed concerns over opaque lending practices prevailing under the base rate regime as well. Generally, the base rate is calculated by banks using various methods as prescribed by RBI. And banks add a spread to this base rate while lending. The spread is dependent upon the customer profile, loan tenure, expected credit losses etc. Thus, every customer is quoted a different rate based on his risk profile. And that's where the problem lies in terms of transparency.

While it is true that the spread can change from customer to customer it is the frequency and the amount of change that is raising doubts. There have been many instances where the spread has been revised upwards without any apparent change in the customer profile. The spread breakdown is also not disclosed to the customer unless asked specifically. Further, banks also reduce the spread just in case the customer to whom they have lent decides to swap his loan with another bank. Spread reduction is used as a customer retention strategy which is discriminatory in nature. That's because those customers who have not displayed any willingness to switch are disadvantaged.

Thus, the current spread calculation practices are quite opaque in nature. In order to ensure more transparency RBI should roll out clear guidelines on spread calculations for banks. A complete spread breakdown should also be provided to the borrowers. This will ensure borrowers to compare the product specific charges (example: administration cost) that are part of the spread. It can be helpful to borrowers in choosing the banks of their choice.

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