Loans against FDs may lose sheen after the proposed Base Rate scheme

From April 1, banks will decide their actual lending rates on loans and advances on the bases of Base Rate system. Thus bankers are saying after the proposed Base Rate scheme comes into effect the loans against fixed deposits (FDs) are going to lose sheen.

At present commercial banks are giving loans against FDs at 1% over the FD rate which means if a depositor he/she is investing money for two-year time period (at 6.5 per cent interest) with a bank, then he/she can get loan up to 90% of the deposit amount at 7.5 per cent.

According to bankers from April 1, as per regulator’s draft circular the fresh loans cannot be given below Base Rate, which can range from 8to 9.5 per cent, in turn increasing the rates on loans against FDs.

A senior public sector bank official pointed out, “People generally avail themselves of loans against FDs in case of an emergency. The advantage of such loans is that even as they meet urgent funds requirement, the collateral (i.e., FDs) continues to earn interest. Therefore, there is always demand for such loans. We hope the RBI makes an exception for such loans”.

On February 10 RBI had issued the draft circular that Base Rate system will replace the existing benchmark prime lending rate system, in order to make credit pricing more transparent.

The base rate will include, cost of deposits, overhead costs, and adjustment for negative carry on cash reserve ratio and statutory liquidity ratio.

Besides loans against FDs, RBI in the circular has not given any clear specification on loans given by banks to their staff. The banker said, “Some banks grant interest-free/concessional loans as part of staff welfare. The RBI circular is silent on whether such loans will also have to be moved to the Base Rate regime.”

Commenting on the flaws in the methodology for computation of base rate, a senior banker said, “One of the main inputs for the computation is the cost of funds. One of the features of cost of funds is the average residual tenor of all the liabilities. Thus, if the residual tenor for any bank is higher, then, there is the likelihood of cost of funds being more.”

As the base rate is not tenor specific therefore, the average remaining tenor of deposits can be around two years.

Thus, rate calculated for a tenor of around two years might not be applicable for loans below that period, say one year.

The banker pointed out, thus it was necessary to lend below the BPLR, which can adjust for the negative tenor.