Is the Base Rate system really transparent?
By Vaibhav Aggarwal
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Base Rate: Issue of transparency resolved?

It has been two years since the base rate system came into effect and its impact is now clearly visible on the banking system. The issue of transparency in determining rates still remains to be addressed. RBI itself has appointed a working group to address this problem. According to RBI governor, D Subbarao, there is no transparency in the customer specific spread, which the banks charge in addition to the base rate. There are times when banks charge a spread revised upwards, without there being any change in the customer's risk profile.

For example, suppose an individual takes a home loan at an interest rate of 8%, bank's base rate being 6.75% and the spread being 1.25%. When RBI raises the base rate, say to 9.75 %, banks increase the interest rate to 11.5%, charging a spread of 1.75% instead of 1.25%.

Also, in case of floating rate loans for the customers having similar credit ratings, new customers are charged lower interest rates than the existing customers. This raises questions on whether banks are discriminating between their customers or not.

The absence of transparency in arriving at a base rate, is often attributed to the fact that RBI has permitted the banks to include charges like risk premium and product premium, which form the spread, to the base rate while calculating the final interest rates which will be offered to a customer. The factors which form the spread are subjective and give the banks scope to charge interest as per their will and wish. The banks also use the spread as a retention tool, to lure the customers to remain with the bank, by offering to reduce the rate by a few points in case the customers want to shift to another lender.

So, when approaching a bank for a loan, customers should keep in mind the spread. When faced with a choice between two banks offering same interest rates, selecting the bank which has a lower spread over the base rate, may prove to be a better choice.

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