Under Sections 21 and 35-A of the Banking Regulation Act, 1949 the Reserve Bank of India possesses statutory authority to regulate the interest rates charged by banks. For over two decades the Bank had relied upon its power of direct control on interest rates, rather than influencing them only through variations in the Bank rate. The Bank had enforced both minimum lending rates and maximum lending rates and made significant changes in the interest rate structure from time to time in the past.
Interest Rates for Advance of Scheduled Commercial Banks:
The interest rates on advances granted by scheduled commercial banks were prescribed by Reserve Bank of India and revised by it from time to time. With effect from 18th October, 1994 Reserve Bank of India abolished the minimum lending rate for advances of over Rs 2 lakhs. Banks are now free to fix their own Prime Lending Rate which will be their Minimum Lending Rate. Concessional rate of interest for Advances up to Rs 2 lakhs were revised by the reserve Bank of India.
In its credit policy announced on April 29, 1998 Reserve Bank of India has allowed the banks to charge interest on advances below Rs 2 lakhs at a rate not exceeding the prime lending rate which is available to the best borrowers of the bank concerned.
In October, 1996 Reserve Bank asked the banks to announce the maximum spread over the Prime Lending Rate for all advances other than consumer credit. While announcing their Prime Lending Rate, banks have been permitted to prescribe their spreads over Prime Lending Rate separately for the loan component and cash credit component. This was intended to encourage borrowers to prefer loan component over cash credit component because of a higher spread in case of the latter. In pursuance of this directive State Bank of India prescribed maximum interest spread of 3.5% on loans and 3.75% on cash credit accounts.
In April 1999, Reserve Bank of India permitted the banks to offer tenor-linked prime lending rates i.e. they can offer different Prime Lending Rates for different maturities.
In October 1999, Reserve Bank of India permitted the banks to charge interest rates without reference to their Prime Lending Rate in respect of the following categories of loans:
i) Loans covered by refinancing schemes of term lending institutions.
ii) Lending to intermediary agencies
iii) Discounting of bills
iv) Advances / overdrafts against domestic / NRE / FCNR deposits.
The permission granted to banks to grant fixed rate loans for project finance was extended by Reserve Bank to all loans in April 2000. Now banks are free to offer all loans on fixed or floating rate basis. But they have to ensure that PLR stipulations as applicable are complied with.
To provide further flexibility to commercial banks to decide their lending rates, in April 2001 Reserve Bank of India permitted them to offer loans at below Prime Lending Rtes to exporters or other credit worthy borrowers including public enterprises on the lines of a transparent and objective policy approved by their boards.
Small loans up to Rs 2 lakhs shall continue to be granted at rates not exceeding the Prime Lending Rate of relevant maturity.
Open market Operations:
Under the open market operations the Reserve Bank sells or purchases Government securities and thus reduces or increases the cash resources of the commercial banks. Open market operations have been used to provide seasonal finance to banks. The banks invest their surplus funds in Government securities during the slack season and sell the securities or borrow against them during the busy season to increase their credit to industry and commerce.