Understanding Base Rate of Loans

Loans by banks are linked to their base rates , below which they cannot lend. The loan rate is usually higher than base rate. Banks arrive at the base rate after looking at their cost of funds and other factors. That is why is base rate different for each bank. Why do banks charge existing customers more than their rate for new customers? Is it a way to fleece customers who they think are stuck with them? We answer the questions on base rate in this article.

What is the base rate?

A base rate is the minimum rate of interest that a bank is allowed to charge from its customers. Unless mandated by the government, RBI rule stipulates that no bank can offer loans at a rate lower than the base rate to any of its customers.  Base Rate includes is common across all categories of borrowers.

 A lending rate is the rate at which banks lend to their customers, it is base rate plus a margin or spread, for example, base rate plus 50 basis points or bps.. The actual lending rates charged to borrowers would be the base rate plus borrower-specific charges, called as the spread or the margin, which include product-specific operating costs, credit risk premium and tenor premium. So, it differs across various segments.

For example from State Bank of India website Base rate and spreads are given below.  Borrowers of loan upto 30 lakh will pay 10.10% p.a interest, of which 9.8% is the base rate and 0.3% is the spread or margin

 Base Rate:  9.80% (w.e.f.  19/09/2013)

Home Loan				SBI CAR LOAN SCHEME
Loan Amount	Spread over the Base Rate	Current effective Rate of Interest(From: 01/10/2013)		Tenure	Rate of Interest
Upto Rs. 30.00 lacs	0.30%	10.10% p.a.		For all tenures	For Term Loan and Overdraft: 0.75% above Base Rate, i.e. 10.55% p.a.
Above Rs. 30.00 lacs	0.50%	10.30% p

Banks are required to exhibit the information on their Base Rate at all branches and also on their websites. 

The base rate may change but the bank cannot alter the spread or the margin at which it has offered loans to existing customers. So, if the base rate comes down from 10% to 9.75%, the interest rate for existing customers will fall from 10.5% to 10.25% (considering a spread of 50 bps).

However, banks can offer new loans at a higher or lower margin, say, base rate plus 25 bps. So, for a new customer, the rate will be 10% (base rate at 9.75%), while old customers will continue to pay 10.25%. Existing borrowers feel cheated by such a difference in rates.

Base rate change affects which kind of loan : Fixed Rate of Loan or Floating Rate loan?

Interest rates on loans depend on various factors, including availability of money in the market (liquidity), inflation and monetary policies.

Fixed rate of loan means the interest rate doesn’t change with market fluctuations. Repayment of loans in fixed equal instalments over the entire period of the loan.

Floating interest rate implies that the rate of interest varies with market conditions. Loans on floating interest rates are tied to a base rate plus a spread thereof. So, if the base rate varies the floating interest rate also varies.

How will change in base rate impact floating loans interest rates?

Any change in base rate will affect the floating rate of interest of loans that are linked to the base rate. For example, if floating rate of interest is 11% (Base rate 9% + margin 2%) and if the base rate increases to 9.25%, the floating rate will be 11.25 (base rate 9.25% + Margin 2%). Similarly, a fall in the base rate will lead to a fall in the applicable floating rate.

Which kind of loan fixed rate of interest or floating should one go for?

It’s a topic of discussion by itself and it depends on many factors but in brief.

• Fixed interest rates  are usually 1-2.5 percentage points higher than the floating rate loans.
• If for any reason the interest rate decreases, the fixed rate loan doesn’t get the benefit of reduced rates and the borrower has to repay the same amount every time.
• Another area of concern is whether the fixed rate home loan is fixed for the entire tenure or only for a few years. This has to be cross-checked with the bank while taking the loan.

Are there any exemptions for the granting loans below Base Rate?

Yes, there are exemptions such as Differential Rate of Interest Scheme(DRI) advances, loans to banks employees as per the HR Policy and loan against own deposits held with the Bank and any other category of loan (ex agricultural)  or advances mentioned by RBI from time to time.

Who fixes Base Rate ?

Reserve Bank of India (RBI) does NOT  fix the base rate.  It has issued broad guidelines to bank as to how they should arrive at the base rate.  Thus, individual bank itself fixes its own base rate.

How does a bank decide its base rate?

Each bank decides its own Base Rate. A host of factors, like the cost of deposits, administrative costs, a bank’s profitability in the previous financial year and a few other parameters, with stipulated weights, are considered while calculating a base rate. For details on how bank calculates base rate one can read RBI guidelines on Base rate.

How often the Base Rate will be changed by Banks ? 

Banks are required to review the base rate at least once every quarter.   Banks can review the same even more than once a quarter.  After review, the Bank may decide to change or continue the same base rate. Change of base rates of State Bank of India and HDFC Bank are given below

STATE BANK OF INDIA
Date	Base Rate
19-Sep-13	9.80%
04-Feb-13	9.70%
20-Sep-12	9.75%
13-Aug-11	10.00%
11-Jul-11	9.50%
12-May-11	9.25%
25-Apr-11	8.50%
14-Feb-11	8.25%
03-Jan-11	8.00%
21-Oct-10	07.60%

HDFC Bank
Date	Base Rate
04-Aug-13	9.80%
30-Mar-13	9.60%
31-Dec-12	9.70%
30-Jun-12	9.80%
13-Aug-11	10.00%
12-Jul-11	9.50%
12-May-11	9.25%
14-Mar-11	8.70%

Why do banks charge existing customers more than their rate for new customers? Is it a way to ‘fleece’ customers who they think are stuck with them?

The base rate may change but the bank do not alter the spread or the margin at which it has offered loans to existing customers. So considering a spread of 50 bps, if the base rate comes down from 10% to 9.75%, the interest rate for existing customers will fall from 10.5% to 10.25%.

However, banks can offer new loans at a higher or lower margin, say, base rate plus 25 bps. So, for a new customer, the rate will be 10% (base rate at 9.75%), while old customers will continue to pay 10.25%. Existing borrowers feel cheated by such a difference in rates.

How to deal with differential rates ?

There are two ways to deal with the problem of differential rates.

• One, you can switch the loan to a bank offering a lower rate. This is easy now as pre-payment penalty on floating rate loans has been abolished. The new bank will charge only a processing fee of 0.5-1% of the outstanding loan. Some banks may even waive the fee if you bargain hard.
• Another option is switching to the lower rate being offered to new customers by paying a small fee. Most banks offer this facility to retain customers.

Why was the base rate introduced ?

The base rate system replaced the Benchmark Prime lending rate (BPLR) system, which was the methodology earlier followed by the banks since 2003. The BPLR varied from Bank to Bank and the variation was quite wide, stretching over 4% sometimes. While initiating the move to replace the existing system of BPLR, RBI felt that the The calculations of BPLR was mostly NOT transparent  and BPLR lending rate system hindered effective transmission of monetary policy signals.  For example, when the years 2008 and 2009, RBI reduced its its benchmark lending rate by 425 basis points banks reduced their BPLR by about 200 basis point .  This was mainly because bulk of their lending was below their BPLR. Although, BPLR of Indian banks ranged between 11 percent and 15.75 percent,  yet three-fourths of their total loans were made below these levels because of competitive pressures in the fragmented banking sector. The base rate makes pricing more transparent as  base rate has to be disclosed publicly and banks are not permitted to lend below base rate.

Why Banks are still continuing with BPLR whereas Base Rate has been made Applicable?

Although RBI has introduced Base Rate as a reference benchmark rate for all floating rate loan products with effect from (wef) 1st July, 2010, yet  RBI has  allowed banks to continue BPLR but only on the loans which have been sanctioned before the introduction of  Base Rate i.e. July 2010 until maturity  These borrowers have the option of approaching the bank to switch to the base rate system before the expiry of their loans.

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6 dumb mistakes which you make while writing Cheque’s – Dont do it !

One of the most common ways to pay money to someone is through cheque’s. Cheque’s give you the flexibility to make payments to someone at some later date (post dated cheque) by writing it now at this moment. Writing a cheque seems to be such a simple task, but do you know that there are many weak links in writing cheques which can create a big problem for you.
If you are not careful while writing a cheque, it can be misused by someone else and potential of monitory loss to you along with unwanted headache. Today’s generation is very causal when it comes to writing  the cheques. In this article, I will cover 6 must know points which you should always practice writing the cheque’s . You can see these 6 points as a step by step recipe to write cheques. Lets see them one by one
1. Do not leave spaces between words or numbers
Its a no-brainier. When you write numbers and words in the cheque, be it Name or amount, never leave a space or gaps between them, because that gives a chance to add some alphabet or number and change the whole cheque.
Imagine you issue a cheque to “ANKIT SHARMA” , but put sufficient space between “ANKIT” and “SHARMA” and it looks like “ANKIT    SHARMA” . One can add an additional “A” after “ANKIT” and the name can become “ANKITA SHARMA” . However if you just leave exact one small space between “ANKIT” and “SHARMA” , its going to be tough to add another alphabet in between.

2. Make sure you cross the cheque saying “A/C Payee” 
If you are going to pay to some person and want to force that the payment should go to the same person bank account, in that case, you should be putting a double cross line on the left-top corner of cheque and write “A/C Payee” or “Account Payee“, which ensures that the money will get credited only to a bank account and not be handed over to someone as CASH over the counter.

A lot of people forget to do this, and if the cheque is misplaced or lost, someone can pose himself as the target person and take the money from bank, I hope you know how easy it is to steal someone’s identity and misuse the documents.
3. Add a line after the name and amount till the end 
I recently learned this point, where you add a running line like —————————- after the name and the amount in the cheque, which ensures that one cant add anything after the name and amount and misuse it .

4. Cancel the word “Bearer”
If you look at your cheque closely, in the “Pay” section, there is space for the name and then on the right corner it ends with “Or Bearer” , which means that either the person whose name is written in the cheque or anyone else who is bearing the cheque can encash it , provided the “A/C Payee” is added to cheque as mentioned in 2nd point above. So you should always cancel the word “Bearer” from the cheque, unless you really want it. This ensures additional safety of the cheque.
5. Add a sign of “/-” after the amount”
Now this might sound so small, but this has lots of wisdom inside this simple trick . There is huge difference between Rs 37,000 and Rs 37,000/- . In first option of Rs 37,000 , you can add more numbers at the end and can make it Rs 37,00000 if there is enough space ahead of it, but in case of Rs 37,000/- , You cant do anything . Below is a simple example of how it can be misused.

6. Keep the details of Cheque’s issued, even if it sounds boring !
And finally, when you give a cheque to someone, write down the cheque number, account name, amount and the date when it was issued or dated, because you might need this information incase you want to cancel the cheque. A lot of times, it happens that you need to cancel the payment, but do not remember the details. Having recorded this information would be handy at times and will help you to act faster.
ICICI Bank also has a small tutorial on correct way of writing cheque’s, which I have added below, just have a look at it and you should understand most of the things.

Use these 6 things everytime you issue a cheque
Next time you write a cheque, just make sure you have done all these 6 things, and the chances of misuse of your cheque will be close to ZERO because each and every step add a security layer. Let me know if you have any tips on writing cheque  in correct manner or any real life experience on this issue.

SIP in equity funds vs Recurring Deposits

Both Systematic Investment Plan (SIP) in equity funds and recurring deposits in banks are used to create a large corpus over a long period of time.

The effect of compounding helps both deliver handsome returns.

One may argue that it won’t be fair to compare the two as they belong to different asset classes, namely equity and debt. But in times of intense volatility in stock markets and high returns offered by banks on deposits, the comparison is inevitable as to which investment option may help investors better to reach their financial targets.

Both, SIP in equity mutual funds and bank recurring deposits, require regular investments and are useful to meet financial targets.

When someone opts to invest in an equity mutual fund through SIP mode, the impact of market volatility gets minimised due to average purchase cost per unit of investment.

Units of mutual funds are bought at different NAVs over a period of time and thus more units are bought when markets are at lower levels.

When markets are falling, one should use that as an opportunity to accumulate more units, which can be sold later when the markets go up. While market volatility may impact short-term return, cost averaging helps one earn better return over a long period of time.

FOR LONG DURATION

If one is looking to build a retirement corpus or a large fund for children’s education or marriage, then it would be better to opt for SIPs in some good equity mutual funds.

Over the last 10 years, diversified equity funds have returned 22.29 per cent on an average, much more than any fixed-income instruments could have offered. Even if one chose to invest in passively managed Index Funds, the return stood at 18.14 per cent over the same period.

However, the one-year, three-year and five-year returns of average diversified equity funds stood at 4.49 per cent, 5.73 per cent and 4.23 per cent, respectively, much lower than interest rates offered by banks or post offices.

FOR SHORT-TERM GOALS

Investments in recurring deposits help one achieve short-term financial goals, especially when the money is needed within five years.

Interest rates offered by different banks are still hovering at higher levels and it would be a good idea to start a recurring deposit to capitalise on higher rates.

For example, if one deposits Rs 5,000 per month in a recurring deposit for five years that yields 9.25 per cent interest, he will get Rs 3,81,817 at the end of the maturity. Some banks are even offering 10 per cent rate on short-term deposits.

In case of recurring deposits, the interest rate offered by the bank remains the same throughout the tenure of the investment, thus cushioning investors from interest rate volatility. Moreover, banks also allow investors to take loan against the deposit account.

BALANCE IN PORTFOLIO

The choice between SIP in equity funds and recurring deposits should be made based on one’s investment horizon, risk appetite and structure of the portfolio. Since the two instruments belong to different asset classes, a mix of the same helps one maintain proper balance. While the equity portion will help boost growth, the debt portion will ensure necessary stability and assured return.

TAX PERSPECTIVE

However, it has to be kept in mind that although one can be sure of the maturity value of a recurring deposit, he/she needs to factor in post-tax returns also.

Though there is no TDS in the case of recurring deposit maturity, the interest amount earned will be added to one’s annual income. In case of SIPs in equity funds, there will be no long-term capital gain tax if units are sold after one year from the date of investment. From return as well as tax perspective, it pays well to stay invested in equities for longer duration.

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When cheques bounce

Cheque bouncing is one of the most common offences in the country, with over 40 lakh pending cases in the Supreme Court. A cheque can bounce for several reasons such as insufficiency of funds, mismatch in signature, stale cheques, post-dated cheques or if there are corrections in the cheque without authentication. The bank collects a penalty from the defaulter when a cheque bounces. The person issuing the cheque can even get a jail term.

All that’s fine, but what are the remedies if you’ve been issued a cheque which has bounced?

LEGAL ACTION

Almost every bank gives a ‘cheque return memo’ along with the returned cheque stating the reason for the bounce. If you hold the cheque, you need to inform the drawer and ask if you can re-present it to the bank within the 3-month period.

If cheque is dishonoured even the second time, then you can take legal action. As a first step, you can send a legal notice to the defaulter within a period of 30 days from receiving the cheque return memo. The notice should contain all necessary details.

The defaulter needs to make a fresh payment within a period of 15 days from the receipt of this notice. If he still doesn’t make the payment within this time period, then you can file a complaint in the magistrate court. This case should be filed within a maximum period of 1 month from the date of expiry of the 15-day period.

Remember that the complaint should be filed within the time frame. If complaints are made outside the time frame, then the case becomes time barred and will not be entertained. When your case comes for hearing, the defaulter can be punished with a jail term for two years and/or a penalty which can be up to twice the cheque amount. The defaulter can appeal against the order within a period of 1 month of judgement.

However, it may not be so straightforward all the time. Here are two common instances when cheques bounce and what can be done.

RENT CHEQUES

Sometimes, it may so happen that the tenant does not have the funds simply because the landlord did not drop the cheque at the expected time. Therefore, the landlord is bound to first inform the tenant and only then proceed with the legal process. There may be another case when the tenant wishes to set off an amount from a particular month’s rent towards some expense he incurred on behalf of the landlord, which the latter refuses to pay. If there is a cheque bounce because of this, the criminal case will continue against the tenant till he is able to establish that there was a legitimate set-off.

EMI CHEQUES

Banks don’t normally file cases against bounced EMI cheques as the first step. Hefty penalties, loan default charges and cheque bounce charges are levied first. These keep building up for every month of default and added to the EMI amount. Also, the defaulter’s credit rating gets affected with every default he makes. In case of secured loans, banks also have the security as collateral. If the borrower does not make payments even after repeated reminders, the bank can give sufficient notice and auction the security to recover the dues.

CEO, BankBazaar.com

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