The new reference rate will consist of two elements, namely Base Rate and “cost plus”. Base Rate is determined by the financial institutions’ benchmark cost of funds and the Statutory Reserve Requirement (SRR). On the other hand, “cost plus” comprises elements such as credit risk profile of borrowers, liquidity risk premium, operating costs and profit margin of financial institutions.
Base Rate should differ marginally from one bank to another. The difference would be in the “cost plus” elements. This means that banks which are more efficient would be able to offer better rates to customers. Under this cost plus structure, spreads will always be positive. Therefore it is impossible for financial institutions to offer lending rates below the reference rates.
The new framework will not bring about any changes in the cost of borrowing for consumers or impact the profitability of banks. After 2nd January 2015, BLR-based loans approved prior to that will continue to be referenced against the BLR. Also, when any bank makes an adjustment to the base rate, a corresponding adjustment to the BLR will also be made.