Floating Home Loan: BPLR vs. Base Rate.
Thinking of taking a loan from a bank? Isn’t it really a difficult choice to make? You might have come across the terms BPLR and Base Rate. In case you are reading this article right now, we will make either one of the two assumptions below:
- You are caught in an infinite loop trying to figure out which one should you be selecting or,
- You are simply curious about the difference between the two so that you can do your school/college homework properly.
Whatever the case be, understanding the difference between the two will require some deep understanding of the banking jargon that circulates in market. Let us try and help you out with your quest. You can thank us later if you want to.
Let us begin…
What is BPLR?
BPLR stands as the abbreviated form of Benchmark Prime Lending Rate. This concept was introduced back in 2003. Let us consider a simple ‘WE/US-YOU/YOUR’ framework for further explanation.
- WE/US: Here WE/US represents a bank. So, we/us are a bank.
- YOU/YOUR: Here YOU represents the customer looking for a loan. So, you are a customer.
…YOU come to us for a loan. WE will provide you the money you need. But, WE cannot give it to YOU for free. WE will charge what is known as interest rate on the money YOU accept from us. So, when YOU return the money, YOU will not on pay US the amount YOU take from US but also the interest amount.
Usually, interest is calculated on a yearly basis. So, if YOU take a loan of say, ₹ 500,000 from US with a promise of paying back the whole money after 1 year and WE charged interest of 14% per year, the total money YOU need to pay back is:
Now, how did WE charge YOU 14% interest in a year? WE will calculate this with a complex set of parameters which include, but are not limited to:
- Administrative costs that WE need to bear.
- WE need to make some profits (just remember that WE are a commercial bank).
- Cost of funds WE hold.
- Non-performing assets that we have.
- Rate at which WE borrow money from Reserve Bank of India (this is known as Repo Rate).
- Cash Reserve Ratio or CRR that WE need to maintain. CRR is the percentage of the total money deposited (either as savings bank account deposit, current bank amount deposit, fixed deposit or any other form of deposit) by all customers taken together of an individual bank. So, WE need to have CRR. The amount of money to be held as CRR is always defined by Reserve Bank of India.
- YOUR credit worthiness. In other words, how trustworthy YOU are when it comes to repaying the loan YOU take out from a bank or a non-banking corporation.
- Then there is something called Spread. This is related to credit worthiness. We will talk about Spread shortly.
Based on all these factors, the interest rate WE can charge is not really 14%. It is usually less than this. Let us assume that taking all factors into consideration, the most relevant interest rate is 11.5% but WE are charging YOU 14%. This extra 2.5% is call the Spread.
Spread can go in either direction. WE can charge YOU less than 11.5% or WE can charge YOU more than 11.5%. Whether WE will charge less or more will depend on how credit worthy YOU are. If YOU have a good history of paying back loans or credits, YOU are very credit worthy but if YOU are terrible with repayments and have a history of defaults, YOU are not very credit worthy. In case YOU are not credit worthy, lending money to you will be a risk because YOU may default and if that happens, WE will lose our money. WE never want that to happen. So, to offset the risk of lending to YOU or just any non-credit worthy person, WE will charge higher interest rate. Usually, YOU will pay at least for some time before defaulting and the additional interest rate WE charge will help US to recover some money WE lend YOU before YOU eventually default. Got it?
What if YOU are extremely credit worthy? In that case, WE may charge YOU even lower interest rate than our calculated 11.5%. So, now WE can go for a negative spread of say, 1.5%. This means that the effective interest rate will be 10% and not 11.5%.
11.5% is OUR BPLR or Benchmark Prime Lending Rate. All lending organizations (banks or non-banks) are required to calculate their own BPLR. RBI never sets this rate for any organization with one exception: “A fixed rate has to be applied for all loans below ₹ 200,000. For anything above that figure, all lending organizations can set their own BPLR and Spread.”
The Disadvantages of BPLR:
Benchmark Prime Lending Rate or BPLR is not good. Why? Here are the reasons:
- BPLR calculations depends on several factors, which in turn are dependent on market interest rates. Fluctuations in market interest rates can lead to erratic swings in BPLR. Since customers are not very clear about BPLR calculations, cost of borrowing money sometimes increases way beyond the affordability limit of customers because lending institutions are free to set their BPLR.
- BPLR is not uniform. Different banks have different BPLR. Again, Spread is not uniform as well. This means that one person borrowing from say, SBI may pay less interest compared to another person borrowing from HDFC Home Finance Company (remember that HDFC Home Finance and HDFC banks are entirely different entities) for the same amount of money.
- Many lending organizations lends money at Sub-BPLR (i.e. interest rate below the BPLR in our example above, it was 10%) to big business. This led to the vicious cycle of rich becoming richer and poor becoming poorer because large corporate enjoyed lower interest rates and hence, had to repay less while making enormous profits by utilizing the loan money. On the other hand, individual users will limited income paid higher interests and hence, had to burn holes in their bank accounts.
- Large businesses often have access to Sub-BPLR rates even though they default.
- Sub-BPLR lending leads to increased borrowing and hence, more money is pushed in market but stays limited to corporate houses. They invest the money, grow their business and earn profits. Business growth does help to generate more employment and mobilization of unused resources but unfortunately such economic growth is offset by the fact that common man ends up with low spending power (because their income remains unchanged), forcing companies to cut down their prices, triggering a ripple of falling prices. This means disappearing profits for companies. They then resort to layoffs and may even end up declaring bankruptcy. That’s when companies default and banks lose money. Banks losing money means that the money deposited by common people is lost, trigger another shock wave. As people lose money, they want to preserve and save. They cut down their expenses and lower their demands further. This leads to further drop in prices of products and services. Economic equilibrium is lost and economy enters a state of deflation and economic growth halts.
Reserve Bank of India noticed this and said, “Well, BPLR is a devil and needs a blow from savior angel”. This is when the Base Rate was formed. Are you ready to understand Base Rate? We hope you are! Let’s begin…
What is Base Rate?
Now that the devil was identified, Reserve Bank of India felt the need of taking corrective measures. So, a new system of lending was born. It was named Base Rate and was implemented on July 1, 2010.
The concept of Base Rate is simple.
This is how it works:
A bank takes a benchmark interest rate from the market. This benchmark is decided by the bank. No one tells it to select a predefined benchmark. Based on the benchmark and the factors like CRR, Repo Rate, administrative costs etc. the bank comes with an interest rate that it will charge for all loans. This rate is called the Base Rate.
The parameters used for deducing the Base Rate are to be transparently reported to RBI and if necessary (just in case a customer asks for) to a customer.
Every bank is free to fix a Base Rate. However, here are the key features of Base Rate:
- Every bank needs to have one and only one Base Rate for a specified time frame (say for 1 year).
- Different banks can have different Base Rates.
- Banks need to revise their Base Rates at least once in one fiscal year.
- Banks are allowed to charge above the Base Rate in case they feel that the customer is not credit worthy.
- Banks are not allowed to lend below the Base Rate.
- Only and only banks fall under this rule. Non-banking institutions like HDFC Home Finance or LIC do not fall under this system. These non-banking institutions can still use BPLR and in case they want to follow Base Rate, they are just welcome to do so.
- Loans that were taken by customers prior to July 1, 2010 will continue at BPLR if the customers want. In case the customers want to switch to Base Rate, banks will be forced to transfer the loans to Base Rate structure from BPLR.
This increased transparency in lending at least as far as banks are concerned.
So, now let us take a comparative look at BPLR and Base Rate. You ready? Yes, you are! You are awesome!
|Parameters of Comparison||Interest Types Compared|
|Benchmark Prime Lending Rate||Base Rate|
|Followed By||Banks and Non-Banking Institutes.||Mandatory for banks to follow. Non-banks may not follow.|
|Positive Spread (Lending above rate)||Allowed.||Allowed.|
|Negative Spread (Lending below rate)||Allowed.||Not Allowed but there are exceptions.|
|Uniformity||No two organizations (banks or non-banks) will have same BPLR. If they have, it is just coincidence or a competitive maneuver.||No two banks will have same Base Rate. If they have, it is just coincidence or a competitive maneuver.|
|Transparency||Customers are unaware how BPLR is calculated.||Banks need to make public disclosure of how the Base Rate is calculated.|
|Transfer from one format to another||BPLR to Base Rate is allowed. Base Rate to BPLR is not allowed. Banks are forced to transfer if demanded by customers. Non-banks will not transfer because they don’t follow Base Rate.||BPLR to Base Rate is allowed. Base Rate to BPLR is not allowed. Since only banks follow Base Rate, they are forced to transfer from BPLR to Base Rate if customers demand.|
|Change in rate||BPLR can change anytime depending on market interest rates.||Base Rate should be revised at least once a year. Such revisions can be made quarterly.|
|Fixed or Floating Interest||Floating interest as it changes with changes in market rates.||Floating interest because rates are revised after specific tenures and such revisions are based on market rates.|
What are the Negative Spread exceptions for Base Rate?
Banks are allowed to lend below Base Rate only under following scenarios:
- Products that have Differential Rate of Interest (or DRI). DRI loans have special eligibility requirements and are usually targeted towards people belonging to low income bracket.
- Loans forwarded to employees of the banks. This includes both current (in-service) and retired employees.
- Depositors taking loans against the deposits they made with their banks.
Now the big question… Which one is better, BPLR or Base Rate?
Let us answer this question with a question. ‘Which one will you prefer – a system that leads to economic collapse and stunned growth or a system that empowers the citizens?’ Of course, you will chose the latter one. So, without a second thought, Base Rate is better because:
- It is transparent.
- It has no negative spread that benefits big corporations.
At least that is what we think. What do you think? Let us know in the comments section.