RBI, the banking regulator is considering to put a ban on loans below the PLR ( Prime lending rate), the benchmark for all floating-rate bank loans.

This would benefit people who borrow at floating rates and SMEs (small and medium enterprises).

The practice of sub-PLR was started a decade ago, when the banks complained to RBI that by not lending below the prime lending rate, they ere losing customers to mutual funds and other lenders who were willing to invest in their short term debt at below PLR rates. RBI had accepted this argument and thus the practice was started.

But this practice had its flaws; it did not effectively transmit changes in policy rates across the banking industry. This led to the constitution of a committee headed by Deepak Mohanty for reviewing the PLR rates.

Mohanty is the executive director for the department of economic analysis and policy (DEAP) and department of statistics and information management (DSIM).

Currently around 75% of loans offered by banks are at sub-PLR rates.

However, if RBI imposes a ban on such loans, the scope to decrease rates only for new customers would be reduced, for instance, today, a bank with PLR of 11% to offer one borrower at 12% and a new borrower at 9% on a floating rate loan. This is because existing borrowers' loans have been fixed at PLR plus 100 basis points while the new borrower is offered a rate of PLR minus 200 basis points. The customers feel cheated as a result of banks exploiting these spreads.

Once the bank fixes the PLR, there will be little room to differentiate rates for the new and the existing borrowers. The banks would be restrained from issuing fresh loans, of over one year tenure, below PLR. And the existing loans would have to be priced according to the new norms.

The PLRs of the public sector banks vary from 11.75 to 12.25 while that of the private banks from 14% to 16%. Earlier, the panel considered placing a cap on sub-PLR loans and coming out with sectoral PLRs. However, sources said that both suggestions are unlikely to resolve issues related to transparency in pricing of loans.

Once the RBI issues the notice to ban sub-PLR loans, large corporates would prefer short term loans since that will allow them to bargain at lower rates and the SMEs would benefit the most because of the transparency on pricing.