Interests rate as a major instruments of resources allocation

Prime lending rate: The prime lending rate is the minimum lending rate charged by the bank from its best corporate customers or prime borrowers. Prime lending rates have been deregulated gradually since April 1992 and the interest rate structure for commercial banks simplified. The six categories of lending rates were reduced to four in April 1992 and to three in April 1993.

The norms relating to the PLR have been progressively liberalized. From October 18, 1994, interest rates on loans above Rs 2 lakh were freed and banks were permitted to determine their prime lending rate. From April 1998, banks were given the freedom to determine the interest rates on loans up to Rs 2 lakh, subject to small borrowers being charged at rates not exceeding the PLR. The Reserve Bank of India advised banks to reduce the maximum spreads over their prime lending rates and announce it to the public along with the announcement of their PLR. The Reserve Bank also gave banks the freedom to evolve differential PLRs. Differential PLRs are different prime lending rates for different levels of maturities. Only a handful of banks came out with differential PLRs. In order to ease the rigidities in the interest rate structure, banks were given the freedom to offer all loans on fixed or floating rates while complying with the PLR stipulation, from April 2000. In April 2001, banks were allowed to offer loans at sub-PLR rates, thereby removing the practice of treating the PLR as a floor for loans above Rs 2 lakh. Although the PLR ceased to be a floor for loans over Rs 2 lakh, it continues to operate as a ceiling for loans up to Rs 2 lakh taking on the role of a benchmark. At present commercial banks decide the lending rates to different borrowers (with credit limit of over Rs 2 lakh) subject to the announcement of prime lending rate (PLR) as approved by their boards. Banks’ PLR will now be on ‘cost plus’ basis that is, banks have to take into account their (1) actual cost of funds, (2) operating expenses and (3) a minimum margin to cover regulatory requirement of provisioning / capital charge and profit margin, while arriving at the benchmark PLR. The minimum lending rates have gradually come down to 11 percent in October 2002 from a peak of 17 per cent in 1992-93.

Generally PLRs across banks area aligned with those of a few major banks who provide the signals for changes in the prime lending rte. The Reserve Bank publishes monthly based on the rates offered by five leading public sector banks.

Bank rate: The rate of discount fixed by the central bank of the country for the rediscounting of eligible paper is called the bank rate. It is also the rate charged by the central bank on advances on specified collateral to banks.

The bank rate is defined in section 49 of the Reserve bank of India Act, 1934 as the standard rate at which the bank is prepared to buy or rediscount bills of exchange or other commercial papers eligible for purchases under this act.

The bank rate was revised only three times in the period between1975-96. It was reactivated in April 1997 with deposit rates (up to one year maturity) linked to it initially. With effect from April 16, 1997, the maximum term deposit rate (up to one year) of schedule commercials banks was set a 2 percent below the bank arte and all interest rates on advances from the Reserve were linked the bank rate. The deposit rates were completely deregulated in October 1997; the other rates continued to be linked to the bank rate. From 1997, basket rate emerged as a signalizing rate to reflect the stances of the monetary policy.

The interest rates on different types of accommodation from the Reserve Banks including refinance are linked to the bank rate. The banks rate is the central bank’s key rate signal, which banks use to price their loans. The announcement impact of bank rate changes has been pronounced in the prime lending rates of commercial banks.