Banks to Do Away With Sub-PLR Rates - Home Loan Takers to Benefit

People who prefer to take home loans at floating rate of interest might get benefited if banks change the method of pricing such loans. But now the Reserve Bank of India (RBI) is planning to forbid the banks from lending below prime lending rate (PLR), the benchmark rate for all floating rate bank loans.

A decade ago banks had taken permission from the RBI to lend below the benchmark rate known as sub-PLR. The banks had argued that if they do not lend below PLR they would lose customers to mutual funds (also other lenders ready to invest in their short-term debt offering rates below PLR.)? Although RBI accepted bankers' argument, from long time it is being felt that the practice of lending loans below PLR is not transparent and not much effective change can be seen in policy interest rates across the banking system.

Therefore to review sub- PLR lending practice, RBI constituted a committee headed by executive director Deepak Mohanty. It has been observed that 75% of loans given by banks are at sub-PLR rates. Also there are possibilities that RBI might not completely forbid such loans. According to people closely watching the proposed development, banks might be permitted to quote sub-PLR rates only on short-term, or on loans given for less than one year.

In case RBI prohibits sub-PLR rates on all loans above a year, then home loans will be priced at PLR or above PLR. Thus banks would probably find it difficult to reduce rates only for new customers by varying the spread between their PLRs and lending rates. Spread is the difference between the BPLR (benchmark prime lending rate) and the loan interest rate. This can be " BPLR plus' x' or BPLR minus" x"

Today when banks reduce interest rates on home loans the benefit of the revised rates is given only to the new borrowers For instance, a bank whose PLR is 11.5% its one borrower is paying 12% on a floating rate loan while bank is offering a loan at 9% to a new borrower. This is because the old borrower's loan was fixed at a rate of PLR plus 50 basis points while the new borrower loan has been fixed at PLR minus 250 basis points. Thus the banks are playing with spread, which make old customers feel cheated.

After RBI puts a ban on lending below PLR and it is fixed as the floor rate, with the maximum rate capped at 400 basis points above PLR, then banks will not have much option to vary rates for old and new borrowers. Looking at this the large corporates would prefer to take short-term loans as they would be able to bargain for lower rates. On the other hand small to mid-size corporates might get benefitted the most as fixing PLR as the floor rates will bring some transparency in pricing of loans.