The evolution of the BPLR can be traced back to September 1990 when the first attempt to rationalize the administered lending rate structure was made by removing multiplicity and complexity of interest rates. According to this structure, the advances of scheduled commercial banks were divided into six slabs and progressively higher interest rates were prescribed for larger advances (subject to a floor rate).
The Benchmark Prime Lending Rate was introduced by the Reserve Bank of India in the year 2003 with the aim of introducing transparency and ensuring appropriate pricing of loans, wherein the lending rates truly reflect the actual costs. It was envisaged as a reference rate and was to be computed taking into consideration (i) cost of funds; (ii) operational expenses; and (ii) a minimum margin to cover regulatory requirements of provisioning and capital charge, and profit margin.
The evolution of the BPLR can be traced back to September 1990 when the first attempt to rationalize the administered lending rate structure was made by removing multiplicity and complexity of interest rates. According to this structure, the advances of scheduled commercial banks were divided into six slabs and progressively higher interest rates were prescribed for larger advances (subject to a floor rate). While for the lowest slab consisting of advances amounting up to Rs. 7,500, a minimum interest rate of 10 per cent per annum was prescribed, advances of above Rs. 2 lakh, which fell under the highest slab, were prescribed a minimum rate of interest of 16 per cent per annum. While the above structure was applied to both working capital and term loans, concessional rates were offered on term loans to agriculture, small-scale industry and specific transport operators.
The next major step in the evolution of BPLR took place in April, 1993, in the backdrop of the financial sector reforms of the early 1990s wherein the credit limit size classes of scheduled commercial banks, on which administered rates were prescribed, were reduced into three slabs; (i) advances up to and inclusive of Rs. 25,000; (ii) advances over Rs. 25,000 and up to Rs. 2 lakh; and (iii) advances over Rs. 2 lakh. In October of the next year with the intent of deregulation of lending rates, it was decided that banks would determine their own lending rates for credit limits over Rs.2 lakh in accordance with their risk-reward perception and commercial judgment. However, banks were required to declare their prime lending rate (PLR) i.e. the rate charged for the prime borrowers of the bank, with the approval of their boards taking into account their cost of funds, transaction cost, etc.
According to the above scheme, PLR acted only as a floor rate for credit above Rs. 2 lakh and wide scale misinterpretation was registered with banks charging lending rates far higher than PLR on a significant portion of bank credit to borrowers with credit limit to over Rs. 2 lakh. In order to stem this practice, in October 1996, it was made mandatory for banks, while announcing the PLR, to also announce the maximum spread over the PLR for all advances other than consumer credit. The next major improvement was the introduction of the ‘loan system’ of delivery of bank credit in April 1995, whereby banks were given the freedom to charge interest rate on the ‘cash credit’ and ‘loan’ components with reference to the prime lending rate approved by their Boards. This was followed in February 1997 by an additional provision wherein banks were allowed to prescribe separate PLRs and spreads (over PLRs) for both loan and cash credit components.
October, 1997 saw the introduction of the Prime Term Lending Rates (PTLR) according to which banks were given the freedom to announce separate PTLR for term loans of 3 years and above while PLR remained applicable to the loans taken for working capital and short-term purposes. The following year in the month of April, PLR was converted as a ceiling rate on loans up to Rs. 2 lakh with the purpose of removing the disincentive to the flow of credit to small borrowers below Rs.2 lakh.
The next major change in this field was the introduction of the Tenor Linked Lending Rate (TPLRs) on April 1999. According to this system, banks could operate different PLRs for different maturities, provided the transparency and uniformity of treatment that were envisaged under the PLR system continued to be maintained. A few months later with the intention of imparting greater operational flexibility to banks in the applicability of PLR, banks were given the freedom to charge interest rates without reference to the PLR in respect of certain categories of loans/credit such as loans covered by refinancing schemes of term lending institutions, lending to intermediary agencies, discounting of bills and advances/overdraft against domestic/ NRE/FCNR (B) deposits.
The new millennium saw the Annual Policy Statement of 2000-2001 which stated that banks were permitted to charge fixed/floating rates on all loans with credit limit of more than Rs. 2 lakh with PLR as the reference rate. The following year, RBI relaxed the requirement of PLR being the floor rate for loans above Rs.2 lakh in its Annual Policy Statement and banks were allowed to offer loans at below-PLR rates to exporters or other creditworthy borrowers. The next major change was to occur as a result of the abundant liquidity available in the market through the years 2001 – 2004. During this period, interest rates in general softened but the same trend was not reflected in the lending rates across all banks. Keeping this trend in mind, the Monetary and Credit Policy for the year 2002-03 advised banks to review the present maximum spreads over PLR and reduce them wherever they were unreasonably high so that credit was available to the borrowers at reasonable interest rates. Banks were also advised to announce the maximum spread over PLR to the public along with the announcement of their PLRs.
Beginning June 2002, RBI was engaged in intensive monitoring and collection of information regarding interest rates from various banks. Based on the information collected, the Mid-Term Review of Monetary and Credit Policy for the year 2002-2003 observed that both PLR and spread were seen to vary widely across banks/bank-groups. Following this, with an aim of introducing transparency and ensuring appropriate pricing of loans, in the Annual Policy Statement of April 2003, the Reserve Bank advised banks to announce a Benchmark PLR (BPLR) with the approval of their boards. The BPLR was seen as a reference rate and was to be computed taking into consideration (i) cost of funds; (ii) operational expenses; and (ii) a minimum margin to cover regulatory requirements of provisioning and capital charge, and profit margin. At the same time banks were asked to discontinue the practice of tenor linked PLR but were allowed flexibility in pricing floating rate loans and advances using market benchmarks and time varying spread in an objective and transparent manner. Also, interest rates on a number of loans and advances such as advances for acquiring residential properties and purchase of consumer durables could be determined without reference to BPLR.
However, in the backdrop of the implementation of this scheme, banks highlighted the need to have differential pricing strategies owing to different risks of defaults in different segments which needed different load factors for capital charges. Banks were of the opinion that there was need for flexibility in loan pricing to reflect in the interest rate characteristics of the product, including credit and market risks and the structuring required. Banks were also concerned about the fact that transaction costs were different for different sectors such as consumer and corporate business accounts.
In view of the above and various other concerns, banks wanted the Reserve Bank to allow separate BPLRs for pricing loans in different sectors. Subsequently, the Mid-Term Review of the Annual Policy Statement for the year 2005 – 06 observed that the system of BPLR had evolved in a manner that had not fully met expectations. The various shortcomings registered were
i) Sub BPLR lending – Competitive pressures are increasingly forcing banks to resort to sub-prime lending. The share of sub-BPLR lending (excluding export credit and small loans) for scheduled commercial banks which was at 28 per cent in March 2002, increased to 77 per cent in September 2008, before declining to 67 per cent in March 2009 . In the case of public sector banks, the share of sub-BPLR lending was 73 per cent in March 2007, declined marginally to 64 per cent by March 2009. The sub-BPLR lending of private sector banks moderated from the elevated level of 91 per cent in March 2007 to 84 per cent in March 2009. Similarly, the sub-BPLR lending of foreign banks, which touched a high of 81 per cent in June 2008, declined to 68 per cent in March 2009.
ii) Non transparency in dealings – RBI has received several representations on the arbitrariness of resetting the lending rates on loans and the benchmark rates used for pricing floating rate products. Many banks charge lending rates with reference to benchmarks which are internal and non-transparent. Additionally, provisions on conditional resetting interest rates are placed as ‘force majeure’ in loan covenants thereby making the terms of contract non-transparent for the borrower.
iii) Downward sticking trend – It is a known feature of this scheme that that while banks were often quick in raising lending rates during an upturn in the interest rate cycle, they were slow to bring down the interest rate in the downturn of the interest rate cycle. The main reason for this is is the large share of deposits contracted at high rates in the past. While reduction of interest rates could lead to repayment or swapping of loans taken by borrowers, the fixed nature of deposit contracts imply that banks would continue to pay higher interest rates despite the general decline in interest rates.
iv) Cross subsidisation in lending – A large loan offered to a highly rated borrower may be offered at a lower rate below the current all-in-cost BPLR due to little risk and savings on account of processing and monitoring costs. While understandable to an extent, such sub-BPLR lending on a large scale has created a perception that large borrowers are being cross subsidized by retail and small borrowers.
In the backdrop of the above disadvantages, the RBI’s working committee has suggested to move to a system of “Base Rate” based pricing of interest rates.