Base Rate

The base rate is the minimum interest rate set by the Reserve Bank of India (RBI) below which banks are not allowed to lend funds to their customers. It is determined to increase transparency and ensure that banks pass the benefit of lower interest rates to their customers.

Overview

• The base rate is the minimum interest rate banks charge customers when lending a loan. Banks are permitted to charge above the base rate.
• It replaced the Benchmark Prime Lending Rate (BPLR) to enhance transparency lacking in the BPLR.
• As per RBI guidelines, banks cannot lend money below the determined base rate. Banks must declare their base rates on their websites to make lending more transparent.
• The base rate considers all risk factors.
• Each bank sets its base rate, so it varies from bank to bank.
• Banks should revise the base rate at least once every quarter or more often as needed.

Calculation

Similar to the Marginal Cost of Fund Based Lending Rate (MCLR), the base rate is calculated using a formula that considers various factors, including the cost of funds, operating expenses, and profit margin. The formula is as follows:

Base Rate = Cost of Funds + Operating Expenses + Profit Margin

The cost of funds includes the interest paid by the bank on deposits, borrowings, and other sources of funds. Operating expenses include the bank’s administrative and overhead costs. The profit margin is the amount the bank earns from lending activities.

Significance

The base rate is significant because it serves as a benchmark for determining the interest rates on various loans and advances offered by banks. It influences the cost of borrowing for individuals and businesses and plays a crucial role in the overall financial system.

Base Rate and MCLR

The base rate is a minimum interest rate set by banks below which they cannot lend to borrowers. It is calculated considering various factors, including:

• Average Cost of Funds: Interest rate paid on deposits.
• Operating Costs: Expenses incurred in day-to-day operations, such as legal fees, stationery, and administrative costs.
• Negative Carry in the CRR: Cost incurred by banks to maintain a specific amount of cash reserves with the Reserve Bank of India (RBI).
• Margin of Profit: Net amount obtained after considering all costs and expenses.

Due to these factors, the base rate may vary from bank to bank. It often reflects the difference in interest rates charged on deposits.

Relationship between Base Rate and MCLR

Before the introduction of the Marginal Cost of Fund Based Lending Rate (MCLR) in July 2011, all loans were governed by the base rate. Prior to that, the Benchmark Prime Lending Rate (BPLR) regulated the banking industry.

Similar to the MCLR, the base rate is the minimum interest rate below which banks cannot lend, with some exceptions allowed by the RBI.

Both the base rate and MCLR aim to improve the transmission of monetary policy and make the methodology of lending rates selection by banks more transparent.

Remember that the base rate is determined by banks based on RBI guidelines, while the MCLR is calculated using a formula prescribed by the RBI.

Average Cost of Funds vs. MCLR

The average cost of funds refers to the average interest rate that a bank pays on its various sources of funding, such as deposits, borrowings, and other liabilities. It represents the overall cost of funds for the bank.

On the other hand, the Marginal Cost of Funds-based Lending Rate (MCLR) is a benchmark interest rate set by banks below which they cannot lend. It is determined based on the current cost of funds and other factors, such as operating expenses and profit margin.

In summary, the average cost of funds represents the overall cost of funding for a bank, while the MCLR is a minimum lending rate set by banks based on the current cost of funds and other factors.

Base Rate Vs MCLR

Both Base Rate and MCLR are interest rates below which banks cannot lend money to borrowers. While they may seem similar, there are key differences between the two: