RBI’s new base rate formula: Will it be helpful?
For the uninitiated, the Reserve Bank of India Governor, Raghuram Rajan recently cut the interest rates by 50 basis points (bps), to a 4 ½ year low of 6.75%. This was done with a view to infuse fresh energy to the fledgling state of the Indian economy.
This unprecedented change turned out to be the best pre-Diwali present for the citizens, and also saw industry specialists lauding the genius move.
Speaking after the big announcement, Mr. Rajan unveiled yet another surprise as he declared that the Indian Central Bank is also working on a new base rate formula. This could potentially have a much larger impact on the EMI payment schemes.
As the Central Bank is expected to finalise the new guidelines for the base rate formula by November end, hopes have been set soaring. But how would this base rate formula benefit you, the common man? Before we head into that, you first need to understand how banks calculate their base rates and how it’s likely to change from FY16-17.
All the different banks in India follow a particular methodology when calculating their base rates. While some use the average cost of funds method, others have employed the marginal cost of funds methods. Then there are some who have adopted the blended cost of funds or liabilities method.
How Will the Rate Be Calculated after April?
Earlier in September, RBI had circulated a directive for banks to adopt the marginal cost of funding method while calculating base rates. This will help bring uniformity and better transmission of rate cuts to prospective borrowers.
The RBI expects lenders to arrive at the cost of borrowing method by taking into account the average rates at which they have raised funds prior to the month of reviewing the rate cut. This method will consist of fixed deposits, current and savings accounts, and borrowing from RBI and other lenders and bonds.
So, now. Back to the billion dollar question.
How Can the Borrowers Benefit?
The are a couple of valid reasons behind the RBI’s move. The main objective was to discipline banks and get them to strictly follow the monetary policies set by the RBI. Other, banks were concentrating more on their profit margins rather than passing the rate cuts effectively.
The recent rate cut coupled with this new formula is sure to leave the borrowers’ bank accounts slightly heavier than before. As the base cuts would trickle down by reducing the lag between lending and deposit rates to ultimately benefit the borrowers.
A Note to Keep in Mind
Once the formula is introduced, the rate cuts will become more transparent while a reduction in the interest rates is also set to happen. But there are also chances that the RBI may likely revise and hike the rates in future.
But with the formulae set to be adopted by all banks, the Central Bank’s directive are sure to have their desired effects with regards to policy measures reaching the consumers.