The central bank, which had formally announced its decision to launch base rate through monetary policy issued in mid-July, is planning to introduce the system in mid-November at commercial banks in the preliminary phase.[break]
“We invited the CEOs of all commercial banks to get their feedbacks and give them a rough idea on the structure of the base rate,” a high ranking official of the Rastra Bank told Republica on condition of anonymity. “We also gave them a tentative formula to compute the base rate.”
Once the base rate is introduced, this will compel all banks to fix the minimum rate for their loans. Since this sets the floor for credit rates, loans should not be extended to borrowers below this rate. Simply put, if a bank fixes a base rate of 10 percent, it won´t be allowed to charge less than this rate on its loans.
“Since these rates have to be revised at regular intervals, this will give borrowers a basic idea about the lowest lending rates. They can then tally this rate with the lending rates being offered to them by banking institutions,” the official said, adding, this would let customers know “if they are being cheated.”
As of now, the central bank has asked all banks to compute base rate based on variables such as cash reserve ratio, statutory liquidity ratio, operating cost and return on asset.
Currently, commercial banks have to maintain six-percent cash reserve ratio, which means at least six percent of the deposits collected by banks have to be parked at the central bank on which no returns are extended.
Similarly, banks have to maintain 15-percent statutory liquidity ratio, which is the portion of liquid assets that banks must maintain in their reserves in cash, treasury bills or government bonds, among others. Since yields on treasury bills have now fallen to less than a percent, banks that could have channeled these funds to high-yielding sectors lose money while investing in these instruments.
“We have asked banks to include these costs while calculating their base rates,” the official said. “Besides, we have also asked them to take into consideration their operating cost and cost involved in generating certain return on assets that are being used to compute the base rate.”
However, banks said the central bank should also allow banks to include cost accrued by keeping 1 percent of the amount that they provision for good loans.
Banks provision certain percentage of the principal amount extended to borrowers to create a cushion in case these loans turn bad.
“Since one percent that we have to provision for loans that are being repaid on time is quite high it can increase our cost of fund,” a banker, who attended Wednesday´s meeting, told Republica.
However, the central bank official said the bank is open to suggestions. “That´s why we called them for a meeting on Wednesday and will continue discussions,” he said.
Related story
Revised interest rate corridor system introduced
