RBI ready to free all lending rates

RBI ready to free all lending rates:

Wants to deregulate rates on loans to small industries,
agriculture and exporters, may also abolish BPLR concept

Feb. 8--In a game-changing move for the Indian financial sector,
the Reserve Bank of India (RBI) is set to deregulate all lending
rates in the next fiscal year, starting in April.

The Indian central bank has in principle agreed to free the
administered rates on loans to exporters, agriculture and small industries.
A draft circular on the proposal will be posted on its website in the next
few days, inviting comments from the public.

At the next stage, it may even deregulate savings deposit rates,
the last bastion of administered rates for liabilities,
a person familiar with the development said.

Currently, both export loans and loans to small farmers
and small-scale industries are mandated by the banking regulator.


In a parallel move, RBI will also abolish the concept of benchmark
prime lending rate (BPLR), or the rate at which banks are expected
to lend money to their top-rated borrowers. The BPLR, introduced in
November 2003, will be replaced by a base rate and no bank will be
allowed to offer any loan at below the base rate.

RBI's decision to deregulate loan rates follows the recommendations
of an internal panel headed by executive director Deepak Mohanty.
The panel was formed in June to review the BPLR system and suggest
an appropriate loan pricing system. The Mohanty panel report was put
up on RBI website in October, inviting comments from public, until 17 November.

"The central bank has by and large accepted the recommendations
of the panel with minor changes," said the person familiar with the
development who didn't want to be named.
For instance, the panel recommended the one-year deposit rate
as a benchmark for the base rate, but RBI is not in favour of any
benchmark for arriving at the base rate.

All it wants is a transparent process to form the base rate that's non-discretionary.
In other words, no loan can be given at below the base rate.

Currently, around 70% of bank loans are given below BPLR, making
a mockery of the concept. Banks keep their BPLR at an artificially high
rate to protect their interest income. This is because both small loans to
farmers and small industries as well as export loans are linked to BPLR
and when the prime rate goes down, the rates on these loans automatically
decline, depressing their earnings.

Loans to exporters are given at 2.5% below a bank's BPLR while
small loans of up to Rs2 lakh given to agriculture, small-scale industries
and the so-called weaker sections of society are capped at BPLR.

For the past few years, banks have been giving small agriculture loans
at 7% with the government offering a 3% subsidy on such loans
through a budgetary provision.

"While the new base rate concept will be more meaningful than BPLR,
the most significant news for the financial sector is complete deregulation
of lending rates. This will change the way banking is done in India.

It will be interesting to see how banks and consumers respond to this,"
said the banking analyst at a foreign brokerage who declined to be
named because the regulator has not yet made the decision public.

According to him, the base rate will be significantly lower than the BPLR.
"It will be in single digit," he said.

BPLRs of public sector banks vary between 11% and 13% and most
private banks charge even more.

Despite this, banks' net interest margin (NIM), or the difference
between cost of funds and earnings on deployment of funds, will
not be hugely affected as their earnings on those loans which have
so far been administered will go up.
The panel had recommended that once the base rate is introduced,
"there will not be any need to extend any concessional export credit",
and if "any special dispensation is considered necessary,
it should come explicitly from the government in the form of interest rate subvention".

However, banks' NIM will be hit once they are forced to offer interest
rates on a daily average basis for savings accounts.

Although the savings account rate is currently pegged at 3.5%, the
average cost of banks is much lower--at around 2.8%--since they
pay interest only on the minimum balance kept between the
10th and the end of a month. But things will change from April.

A savings account is the most common operating account for
individuals and others for non-commercial transactions.
Banks generally put a ceiling on the total number of withdrawals
permitted and stipulate a certain minimum balance to be
maintained in such accounts.

With the rise in cost of savings accounts from April, banks
want RBI to bring down the interest rate from 3.5%.
The central bank is not willing to do so and instead it may
free this rate. It has asked the Indian Banks' Association,
the national bankers' body, to prepare a report on this.

The option of capping the savings bank rate at the existing 3.5% and
allowing banks to fix the rate within the cap is ruled out because that
will benefit only banks and consumers will not gain.

"We need to study this and see how banks and the consumers
get affected if the savings account rate is freed.

It cannot be done in a hurry," said a senior RBI official
who did not want to be named.