Lending Rates- PLR, BPLR and BR- An Overview

The interest rate on lending was de-regulated by RBI in October 1994. This was as part of the financial sector reforms initiated in India in 1991. Since 1994, RBI has introduced various benchmarks and guidelines with regard to interest rate on credit. Improving competition in banking sector, enhancing efficiency of banks and ensuring better transmission of interest rate changes announced during monetary policy were the main objectives of these measures. Prime Lending Rate (PLR), Benchmark Prime Lending Rate (BPLR), Base Rate (BR) and the existing Marginal Cost of Funds Based Lending Rate (MCLR) are the different systems adopted by RBI.  During the monitory policy announcement in December 2018, RBI indicated that banks will have to shift to external benchmark linked interest rates from April 1, 2019. Though announcement was made to release guidelines by December 2018, no directions have been issued so far. RBI might be assessing the various challenges in interest transmission faced during the earlier regimes. Meanwhile, SBI has announced its decision to implement external benchmark linked interest rate. 

Financial sector reforms in India and Narasimham committee

Till 1991, banks in India were under an administered interest rate regime. Banks were required to utilize major portion of deposits mobilized, for meeting obligations under SLR and CRR and this in effect affected credit deployment. Highly regulated environment was affecting the efficiency and quality of functions of banks. Indian banking sector began a new phase with the implementation of recommendation of the committee headed by Narasimham. The recommendations included among other things, reduction in SLR and CRR, end of administered interest regime, enhanced capital adequacy norms, opening up of financial sector for new players, promotion of financial inclusion and modification in NPA norms and income recognition.  Since, then India has seen fast pace of growth, moving from strength to strength and today the country is the fastest growing country in the world.

Prime Lending Rate (PLR)

The first step towards deregulation of interest rate, both deposit and lending rate, was initiated by RBI in October 1994. On credit side, RBI deregulated lending rates for credits above Rs. 2 lakh. As part of this, Banks were required to declare Prime Lending Rate (PLR). PLR was envisaged as the interest rate chargeable for the most creditworthy borrower. This was a floor rate calculated by taking into account various components like cost of funds and transaction costs. All the loans above Rs. 2 lakh were extended by linking interest rate to PLR. Banks charged spread over PLR, based on the risk each borrower carried. 
 
Prime Lending Rate carried the following deficiencies
 
a.    Both PLR and spread varied widely among banks and lacked transparency
b.    It failed to capture the direction of interest rate movement in market
c.    Appropriate pricing in relation to the creditworthiness of borrower could not be ensured. 

Benchmark Prime Lending Rate (BPLR)

BPLR regime came into existence in April 2003, in place of PLR. Benchmark Prime Lending Rate was arrived at by considering the cost of funds, operational costs, minimum margin to cover regulatory requirements (provisioning and capital charge), and profit margin. There was no restriction on sub-BPLR lending and as per the estimates of RBI, sub-PLR lending was as high as 77 per cent of long term lending in September 2008.
 
Benchmark Prime Lending Rate had  the following deficiencies
a.    Calculation of BPLR lacked transparency
b.    Comparison of BPLR among banks remained difficult for borrowers
c.    Banks resorted to sub-BPLR lending
d.    Home loans and consumer durable loans were outside the purview of BPLR leading to cross -subsidisation among borrower categories

Base Rate (BR)

Base Rate (BR) regime began in July 2010, by replacing BPLR system. Categories of loan mentioned below were kept outside the purview of Base Rate.
 
(a) Differential Rate of Interest (DRI) advances;
(b) Loans to own employees of banks
(c) Loans to customers against their own deposits with the bank
(d) Agricultural loans (with interest rate subvention given by the government)
(e) Export credit in rupee and
(f) Specified cases of restructured loans.
  
Banks were required to fix Base Rate considering
 
a.    cost of borrowed funds
b.    Negative carry on SLR/CRR
c.    Unallocatable overhead
d.    Average Return on Networth
Base Rate = a +b+c+d
 
Linking the lending rate to cost of fund was expected to ensure transparency, better pricing and interest transmission of monetary policy. Banks were given freedom to consider cost of deposit based on average, marginal or blended cost. Under Base Rate, the single rate decided by bank was to be the minimum rate for all loans except the excluded categories mentioned above. Base rate was to be reviewed on quarterly basis. No period was specified for reset of contracted rate.  Banks were required to add borrower specific charges, if any, to the BR to arrive at the lending rate.
 
However, Base Rate too failed in attaining the intended goals because of the following reasons:
 
a.    Freedom given to banks to select either of average, marginal or blended cost of deposit made the rate non-transparent and non-comparable for assessment of transmission of interest rate
b.    Banks often squeezed spread over base rate for new customers, but continued without reduction for existing customers. This led to discrimination between existing and new customers.

These drawback paved way for introduction of existing Marginal Cost of Funds Based Lending Rate System (MCLR)  effective from April 1, 2016. RBI has proposed to replace MCLR with interest rate linked to External Benchmark, but the implementation is pending.