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RBI PROPOSAL ON BASE RATE

The timing of recent proposal by RBI to introduce base rate mechanism for lending activities could not have been better. Taking the experience of global financial crisis in which Indian Banks remained more or less unscathed, there must be a transparency in systems followed by the Banks to lend money prudently. Banking is a business, where safety of depositors money is of utmost importance.

By lending below the average cost of the Bank, the bank jeopardise the safety of depositors fund as well as start a rate war among the lending institutions, that may be beneficial for the Bank as well as immensely beneficial for the borrower in the short term, it may be harmful for the banking system as a whole. The basic question is why should banks lend money at less than the cost of the fund to the bank? If strategically lending is done to select customers at rates below cost of funds, this has to be cross subsidised by higher rates for many more borrowers. There starts a disparity among borrowers and the retail customers are the worst affected. As far as lending to agriculture sector is concerned, that is done at a rate of 7% at present. But the people must know that large corporates are able to get the loans even cheaper than the farm rates. It may also be noted that the deposit rates for small depositors are far less than the corporate deposits.

Why base rate regime is also required that at present in order to inflate the bank balance sheet size, banks are taking huge deposit and in the absence of credit growth, banks are compromising on credit quality and funding in sensitive sectors like real estate. Banks are also parking huge funds in RBI Reverse Repo at current rate of 3.25% and in liquid mutual funds at rates much below the average cost of funds of the bank. The present situation inflates the balance sheet size unnecessarily that may create asstes bubble in the Indian market.

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