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Base Rate Vs BPLR

Posted on: 6/20/2016 4:23:39 PM

BPLR is the Benchmark Prime Lending Rate and is the rate at which banks in the country lend money to their most credit worthy customers. Till now, RBI had given a free run to the banks to fix their BPLR and different banks do have different BPLR causing resentment among customers. Keeping all this in mind, RBI has suggested the use of a Base Rate in place of BPLR from July 1, 2011 that will be applicable to all banks across the country.

The difference between BPLR and Base Rate is that now the banks are given parameters like cost of funds, operational expenses, and a profit margin that banks have to provide to RBI as to how they arrived at their base rate. On the other hand, though there were similar parameters in case of BPLR also, they were in less detail and also RBI did not have the power to scrutinize BPLR of the banks. Now the banks will be forced to follow a consistent method of calculation as against arbitrary methods they chose while calculating BPLR.

Earlier banks gave loans to blue chip companies at rates even lower than their BPLR and compensated by giving loans at higher rates to common consumers but now they have been asked not to give loans at a rate lower than the Base Rate. All this obviously means the system of Base Rate will be more transparent than BPLR system.

What is BPLR? 

The BPLR means the Benchmark Prime Lending Rate.   BPLR is the interest rate that commercial banks used to charge to their most credit-worthy customers.  Although as per Reserve Bank of India rules, Banks are free to fix Benchmark Prime Lending Rate (BPLR) for credit limits over Rs.2 Lakh with the approval of their respective Boards yet BPLR has to be declared and made uniformly applicable at all the branches. However, with the introduction of Base Rate concept, BPLR is slowly losing its importance and is made applicable normally only on the loans which have been sanctioned before the Base Rate has been made compulsory.

What is Base Rate?

The Base Rate is the minimum interest rate of a Bank below which it cannot lend, except for DRI advances, loans to bank's own employees and loan to banks' depositors against their own deposits.

The actual lending rates charged to borrowers would be the Base Rate plus borrower-specific charges, which will include product-specific operating costs, credit risk premium and tenor premium.  

What is the difference between BPLR and Base Rate?

The Reserve Bank of India (RBI) committee on reviewing the benchmark prime lending rate (BPLR) recommended that the BPLR nomenclature be scrapped and a new benchmark rate — known as Base Rate — should replace it.   Base Rate is much more transparent and banks are not allowed to lend below the base rate (except for cases specified by RBI).   Base Rate is to be reviewed by the respective banks at least on quarterly basis and the same is to be disclosed publicly.   On the other, the calculation of BPLR was mostly not transparent and banks were frequently lending below the BPLR to their prime borrowers and also under pressure due to various reasons.

 

Important Credit Parameters

Posted on: 6/20/2016 4:27:32 PM

CREDIT APPRAISAL

Credit appraisal is a skill which has to be acquired by study and supplemented by practice. The credit managers of banks and Non Banking Finance Companies (NBFCs) are duty bound to accept or reject a proposal on the basis of its viability or non - viability.

Credit appraisal is done by banks or financial institutions by obtaining credit information of the borrower. A Bank or Financial Institution considers following Parameters for appraisal of Loan application.

The borrower should make sure that the following information required for processing credit requests are collected by the company for submitting it to the bank or financial institution in order to obtain the required credit facility:

1. Basic background information on the company

This includes

  • Name, domicile and ownership of the company

  • Names of shareholders and directors

  • Nominal and paid up capital

  • Legal status

  • Line of business (full description of the business activities)

  • Brief history of the company highlighting major developments in the methods of trade, product mix and other factors central to the performance of the company.

2. Required facility

This should include the following:

  • Amount

  • Type of credit facility

  • Purpose of facility (details of the end –use of the facility requested)

  • Tenor of facility

  • Schedule of draw downs.

3. Key industry dynamics

The company should highlight key industry players as well as provide comparison of its performance and standing in the industry compared with its competitors. Information should also be provided on the following:

The company’s competitive advantages vis-à-vis the other players giving details of the critical success factors:

  • List of major competitors and their market share

  • Market share of the company

  • List of major buyers with details of the selling terms

  • List of major suppliers with details of the terms of purchase

  • Key industry risks as well as how the company mitigates them

  • Description of the trade cycle of the business

  • Seasonality of the operation giving details of peak and slack seasons.

4. Management

The company is required to provide:

  • A detailed organization chart

  • Information on the key personnel (of the rank of departmental heads and above) which should include, the name ,age, educational background, years of experience, line of operations and ports held present position and description of duties and responsibilities.

5. Management information system

Details of the planning, controlling and monitoring systems which have been put in place have to given.

6. Financial Statements

Financial statements contain a wealth of information. If properly analyzed and interpreted, they can provide valuable insights into a firm’s performance and position. Financial analysis determines the significant operating and financial characteristics of a firm form accounting data and financial statements. The goal of such analysis is to determine the efficiency and performance of the firm’s management as reflected in the financial records and reports.

Analysis can be done through:

A. Ratio Analysis

B. Trend analysis

C. Reading of notes to accounts and other information

A. RATIO ANALYSIS:

Ratio analysis is the science of deriving certain conclusions by a study of such ratios.

Some uses of ratios are:

  • To compare different companies in the same industry.

  • To compare different industries.

  • To compare performance in different time periods.

The ratios to be looked into are:

  • Liquidity ratio

  • Profitability ratio

  • Efficiency ratio

  • Leverage ratio

B. TREND ANALYSIS:

Trend analysis can be through:

a. Intra firm comparison that is review of the trend of the ratios over the years within the firm and

b. Inter firm comparison.

The trend analysis may even be related to absolute figures, such as growth in rates, net worth etc.

C. NOTES TO ACCOUNTS

Financial statements are dressed - up accounts to give the best possible performance outlook of a company. Careful reading and analysis of the notes on accounts, one can gauge the policies of the management, performance of the company, and its future planning.

These can be obtained from:

These would include:

  • The notes to accounts

  • Directors report

  • Auditor’s report

  • Other data published in the annual report.

7. Security

List of properties to be pledged

  • Value of each property (as supported by a professional valuation) ;

  • Whether the property is being used to secure loans from another lender ; if so details of commitments are needed ;

  • Location of the property proposed as security.

8. Present banking relationship

The bank requires full details of the present credit facilities being enjoyed at the moment. In particular:

  • Types of facilities

  • Amount approved

  • Date approved

  • Outstanding balance

  • Repayment terms

  • Due date

  • Securities provided

  • Ability of the company to meet its current borrowing obligations.

9. CIBIL Score

Last the most important thing is CIBIL Score. CIBIL Score plays a critical role in the loan approval process. Your credit score gives loan providers an indication of your capability to pay back a loan. Every lender that uses the Cibil score has its own benchmark of what constitutes a “good score”.

Financial Institutions also obtained information of the borrowing company from following sources:

1. BANKS AND FINANCIAL INSTITUTIONS REFERENCES

The source of primary information can be from the banks and financial institutions themselves which are the most original, the most detailed and by far the most trustworthy source, and as much relevant information as possible may be sought from the prospective banks.

Information about the general financial health of the companies would come from the bankers with whom the company has its account, but also the bankers who might have lent to the company. Getting a reference through the company’s bankers makes it easy to get correct information and the lending banker may remain disguised.

2. TRADE REFERENCE

They are references from the company’s customers, suppliers, etc. Supplier’s information would be particularly useful because, that would give an idea of the usual payment policies of the company.

3. PERSONAL DISCUSSION

This is the most significant source of primary information which is original, detailed and most trustworthy.

Type of borrower:

  1. History of the company, background of the promoters, nature of the company’s business, that is whether first generation entrepreneur (newly started) or established (in the field)

  2. Character: If the customer is honest and is prompt in paying the dues that he has undertaken to pay.

  3. Market, product (share of market, competition, price, sales volume).

4. FACTORY VISIT

Under factory visit information collected are:

  1. Operating capacity

  2. Infrastructure and other utilities

  3. Labor relations

  4. Internal control system for raw material (imported, indigenous)

 

RBI Policy Rates and Reserve Ratios

Posted on: 7/3/2016 12:07:05 PM

Policy rates and reserve ratios

Bank Rate

Bank Rate is a tool, which central bank uses for short-term purposes. RBI lends to the commercial banks through its discount window to help the banks meet depositor’s demands and reserve requirements. The interest rate the RBI charges the banks for this purpose is called bank rate. If the RBI wants to increase the liquidity and money supply in the market, it will decrease the bank rate and if it wants to reduce the liquidity and money supply in the system, it will increase the bank rate.

Any upward revision in Bank Rate by central bank is an indication that banks should also increase deposit rates as well as Base Rate / Benchmark Prime Lending Rate.  Thus any revision in the Bank rate indicates that it is likely that interest rates on your deposits are likely to either go up or go down, and it can also indicate  an increase or decrease in your EMI.

  

Repo (Repurchase) rate is the rate at which the RBI lends shot-term money to the banks against securities. When the repo rate increases borrowing from RBI becomes more expensive.  Therefore, we can say that in case,  RBI wants to make it more expensive for the banks to borrow money, it increases the repo rate; similarly, if it wants to make it cheaper for banks to borrow money, it reduces the repo rate

 

Reverse Repo rate is the rate at which banks park their short-term excess liquidity with the RBI.  The banks use this tool when they feel that they are stuck with excess funds and are not able to invest anywhere for reasonable returns.     An increase in the reverse repo rate  means that the RBI is ready to borrow money from the banks at a higher rate  of interest. As a result, banks would prefer to keep more and more surplus funds with RBI.

 

Thus, we can conclude that Repo Rate signifies the rate at which liquidity is injected in the banking system by RBI, whereas Reverse repo rate signifies the rate at which the central bank absorbs liquidity from the banks

 

Cash Reserve Ratio (CRR)

Every commercial bank has to keep certain minimum cash reserves with RBI. RBI can vary this rate between 3% and 15%. RBI uses this tool to increase or decrease the reserve requirement depending on whether it wants to affect a decrease or an increase in the money supply. An increase in Cash Reserve Ratio (CRR) will make it mandatory on the part of the banks to hold a large proportion of their deposits in the form of deposits with the RBI. This will reduce the size of their deposits and they will lend less. This will in turn decrease the money supply.

RBI uses CRR either to drain excess liquidity or to release funds needed for the growth of the economy from time to time. Increase in CRR means that banks have less funds available and money is sucked out of circulation. Thus we can say that this serves dual purposes i.e.(a)  ensures that a portion of bank deposits is kept with RBI and is totally risk-free, (b) enables RBI to  control liquidity in the system, and thereby, inflation by tying the  hands of the banks in lending money.

 

For Example- When a bank’s deposits increase by Rs100, and if the cash reserve ratio is 6%, the banks will have to hold additional Rs 6 with  RBI and Bank will be able to use only Rs 94 for investments and lending / credit purpose. Therefore,  higher the  ratio (i.e. CRR), the lower is the amount that banks will be able to  use for lending and investment.  This power of RBI to reduce the lendable amount by increasing the CRR,  makes it an instrument in the hands of a central bank through which it can control the amount that banks lend.  Thus, it is a tool used by RBI to control liquidity in the banking system.   

 

Statutory Liquidity Ratio (SLR)

Apart from the CRR, every bank is required to maintain at the close of business every day, a minimum proportion of their Net Demand and Time Liabilities as liquid assets in the form of cash, gold and un-encumbered approved securities. The ratio of liquid assets to demand and time liabilities is known as Statutory Liquidity Ratio (SLR).  An increase in SLR  also restrict the bank’s leverage position to pump more money into the economy.

Higher liquidity ratio forces commercial banks to maintain a larger proportion of their resources in liquid form and thus reduces their capacity to grant loans and advances, thus it is an anti-inflationary impact. A higher liquidity ratio diverts the bank funds from loans and advances to investment in government and approved securities.

In well-developed economies, central banks use open market operations—buying and selling of eligible securities by central bank in the money market—to influence the volume of cash reserves with commercial banks and thus influence the volume of loans and advances they can make to the commercial and industrial sectors. In the open money market, government securities are traded at market related rates of interest. The RBI is resorting more to open market operations in the more recent years.

 

 Generally RBI uses three kinds of selective credit controls:

  1. Minimum margins for lending against specific securities.
  2. Ceiling on the amounts of credit for certain purposes.
  3. Discriminatory rate of interest charged on certain types of advances.

Direct credit controls in India are of three types:

  1. Part of the interest rate structure i.e. on small savings and provident funds, are administratively set.
  2. Banks are mandatory required to keep 24% of their deposits in the form of government securities.
  3. Banks are required to lend to the priority sectors to the extent of 40% of their advances.

 

 

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