Interest Rates on Retail Loans

 It has been a while since the Reserve Bank of India introduced the concept of Base Rate. This wassupposed to bring in transparency in a market where the determination of lending rates was opaque and arbitrary.  It looks like the Base Rate is not achieving much, and the banks are merrily continuing in their old ways, albeit in a new garb.
 
Previously every bank had its BPLR or “Base Prime Lending Rate” which was different for each category of loan. Say you were taking a housing loan from PNB, you would be offered the loan at, say, PNB Housing Loan BPLR (13%) less an arbitrarily fixed delta, say in this case 3%, making the floating rate 10% for you.  Other loans would have a different PLR, and a different delta. Ditto for every other bank, each of whom had their own Base Rates.
What happened when RBI raised the interest rates by increasing the Repo rate by 0.5%? The bank would promptly reset its housing loan BPLR to 13.5% and send all its housing loan customers a letter informing them about the reset interest rate based on the formula “BPLR plus delta”.  In this case your rate would rise to 10.5% (BPLR of 13.5% less 3% which is fixed for your housing loan).   What happened to new customers? Ideally, the bank would have liked to raise the rate for new customers as well, but competition being fierce in the housing loan market, it would be unable to do so. So the new customer would be offered the housing at BPLR less a delta of 3.5%, which is to say, at 10%!
RBI would keep raising the interest rates, and you would keep getting letters from the bank. Most borrowers would not even read their letters, or if they did, ignore them, since the implications are too hard to contemplate. Since the EMI’s would not go up, people would not feel the immediate pinch. However, what actually happens in such a case is that the tenure of the loan keeps inching up – I know of cases where the loan tenure went up from 15 years to 25 years! 
One fine day, you the borrower would realize that another bank is willing to take over the loan at 2.5% lower than what you are paying, and you would approach your bank for prepayment, willing even to pay the 2% prepayment charge that was a standard part of any housing loan. This was when your bank would wake up and offer to reduce the interest rate on your loan by a like amount. For the banks, this is of course a far better strategy than to offer across-the-board reductions as and when the rates fall.
RBI realized that the “BPLR” was not serving any purpose since most loans were being lent below BPLR, and that there was no transparency in changes effected to interest rates when benchmark rates were revised.  So in July 2010, the BPLR was replaced by the Base Rate. The Base Rate, which each bank fixes, is a rate determined taking into account its cost of funds and other factors like cost of operations, CRR and non-performing assets.  This was supposed to usher in an era of transparency, though as to how, no one really specified.
The recent reduction in Repo rate by 0.5%, coupled with the CRR reduction that was announced before that is a good time to test what is happening. Most banks have not reduced their Base Rate at all (which says a lot about “transmission of monetary policy”!). SBI, among the couple who did, reduced its rates, but not as expected, by resetting the Base Rate, nor by effecting an across the board reduction in the “deltas”.  It has announced that it has cut the rates for auto loans and SME loans (loans given to small and medium enterprises).
This raises several questions.  How do we know that the rates are actually cut, given that the deltas could be different for different customers, and different again for new customers? Why has the rate not been cut for other loans? If rates could be arbitrarily reduced for some loans, in future they could of course be increased in the same fashion. What is the guarantee that old customers are not getting cheated the same way as in the past, i.e., by new customers getting lower deltas? As to the answers, it is quite obvious – the system is not really interested in transparency – the old game continues in spite of the change in nomenclature.
How is it in other countries? In the US, all consumer and retail loans are linked to the prime lending rate, and the corporate loans are linked to the London Interbank  Offered  rate (Libor). In the UK, the Bank of England’s base rate is the benchmark for consumer and retail loans, while for commercial loans it is the Libor.  The Indian counterpart of Libor is the Mibor (Mumbai Interbank Offered Rate) which is an overnight rate – there are no three-month or six-month rates yet. Developing that, and making banks use those rates as benchmark rates for all loans, is a long way away!
If you have any loans, whether a housing loan or a personal loan which you had obtained a year or two back, just check what the newer customers have got.  If you find that they are getting cheaper rates, you can approach your bank to get your interest rates reduced. They may do it, or they may not; but if they do it, it will be only after a lot of effort on your part, something that will prevent you from trying it too often.
One good thing is that RBI has done away with prepayment charges on housing loans. This makes it easier to negotiate when it comes to housing loans, but for other loans where prepayment charges are usually to the order of 4%, even prepayment may not be a real option.
There was a brief period (in the years 2001, 2002) when interest rates had hit a low. Housing loans were available at 7.5-8%. Strangely fixed rate loans were also available at the same rate. A situation of low interest rates coupled with no fixed rate premium was brilliant for obtaining fixed rate loans. Those who obtained fixed rate loans or converted their existing loans to fixed rate loans, are the happiest lot!  Unfortunately, the situation today is that rates are quite high, and the fixed rate premium on housing loans is about 2%, making it a bad idea to take fixed rate loans. However, keep watching the market. It is possible that you could get a brief window where going in for fixed rate loans make sense. You can pay an additional charge and convert.
Currently, if you are in the market for loans, the best loan to take is a housing loan. The terms of repayment are good, and the interest rates are the lowest among retail loans. There is also another loan called “Loan against property” which has higher interest rates, and not-so-good prepayment terms, etc. but to me that looks the next best option, along with gold loans. When you are taking a loan you should also ask the bank about the option where a savings account with checkbook is linked to the loan account, and the interest that is charged is on the net balance (loan less  balance in “attached account”). This will enable you to in effect earn the same interest rates on your savings as that of the loan.
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