Yet again the RBI raises Interest Rates to tame the shooting inflation

The Reserve Bank of India springs back to action to tackle the mounting inflation much before the upcoming credit policy on 27th of July 2010

The RBI raises the Repo Rate (the rate at which banks borrow money from RBI for an overnight period) from 5.25 to 5.5

It has also increased the Reverse Repo rate (the rate at which RBI sucks excess liquidity from the markets) from 3.75 to 4.

The RBI seems to have gone for the rate hike for the following reasons

1) Strong IIP numbers over couple of months especially in the capital goods sector.

2) Phenomenal growth in credit offtake for banks that has risen from 10% ( October 2009) to 20% (May 2010)

3) Unabated rise in inflation numbers.

The above move comes as a part of governments plan to move out of the expansionary policy in a calibrated manner.

At this juncture it would have not been prudent to raise Cash Reserve Ratio ie CRR as currently there is a liquidity crunch in the system. The banks are nearly short of 50,000 crs of funds as a lot of money on account of advance tax payments, 3G and BWA auctions had moved from the banks into coffers of the Government. However soon this will reverse as Government pays salaries and makes other payments.

Moreover today itself the Government did a bond auction worth Rs 10,000 crs and one more bond auction worth Rs 35,000 crs is scheduled for July 28.

Thus the liquidity in the system would soon become comfortable and our EMIs may not suddenly inch up at-least not before the upcoming credit policy.

The new base rate regime

Why did RBI banished the Benchmark Prime Lending rate, popularly known as BPLR and replaced it with the new Base Rate?

To start with, BPLR means the rate of interest that the banks would charge on the loans given to its best customers. However nobody quite understood how did the banks arrived at this rate and everybody used to get loans at sub PLR rates
Well this meant that something definitely was amiss.

This let to the introduction of the Base Rate.
Base Rate is the minimum rate that the banks incur.

Calculation of Base Rate

= Cost of deposits
+ Cost of running the bank.
+ Reasonable Return on its money

With its implication from 1st July itself, no bank can lend to its customers (except exempt categories as per RBI Guidelines) below its base rate.

The biggest public sector bank of India has set its Base Rate at 7.5%

Calculation of base rate for SBI

Cost of 6 month deposits = 5.4%
+ Negative Cost on CRR/SLR = 55 bps
+Unallocated Costs
(eg Running the bank)
+ Estimate profit margin
========================================
BASE RATE = 7.5%


All the other banks have followed the leader and have adjusted their base rate to be in the same range by playing around with either unallocated costs or estimated profit.

Below is the list of Banks with their respective base rates.



However before the regime of base rate, the AAA corporates used to get loans at around 6.5%. So will this affect the corporate borrowing. To deal with this the banks may lend money to AAA corporates through commercial paper or give them higher rate of interest on their deposits.