RBI/2010-11/72
DBOD.No.Dir.BC.9 /13.03.00/2010-11

July 1, 2010
Ashadha 10, 1932(Saka)

All Scheduled Commercial Banks
(excluding RRBs)

Dear Sir / Madam

Master Circular - Interest Rates on Advances

Please refer to the Master Circular DBOD.No.Dir.BC.10/13.03.00/2009-10 dated July 1, 2009 consolidating instructions / guidelines issued to banks till June 30, 2009 on matters relating to Interest Rates on Advances. The Master Circular has been suitably updated by incorporating instructions issued up to June 30, 2010 and has also been placed on the RBI website (http://www.rbi.org.in). A copy of the Master Circular is enclosed.

Yours faithfully

(A.K.Khound)
Chief General Manager

Encl: as above

CONTENTS

MASTER CIRCULAR ON INTEREST RATES ON ADVANCES

A. Purpose

To consolidate the directives on interest rates on advances issued by Reserve Bank of India from time to time.

B.  Classification
 
A statutory directive issued by the Reserve Bank in exercise of the powers conferred by the Banking Regulation Act, 1949.

C. Previous instructions

This Master Circular consolidates and updates the instructions on the above subject contained in the circulars listed in Annex 5.

D. Application

To all scheduled commercial banks, excluding Regional Rural Banks.

Structure

1. Introduction

2. Guidelines

2.1  General
2.2  Base Rate
2.3  Applicability of Base Rate
2.4. Floating rate of interest on loans
2.5. Levying of penal rates of interest
2.6. Enabling clause in loan agreement
2.7. Withdrawals against uncleared effects
2.8. Loans under consortium arrangement
2.9. Charging of interest at monthly rests
2.10. Zero percent interest finance schemes for consumer durables
2.11. Excessive interest charged by banks

1. Introduction

1.1. Reserve Bank of India began prescribing the minimum rate of interest on advances granted by Scheduled Commercial Banks with effect from October 1, 1960. Effective March 2, 1968, in place of minimum lending rate, the maximum lending rate to be charged by banks was introduced, which was rescinded with effect from January 21, 1970, when the prescription of minimum lending rate was reintroduced. The ceiling rate on advances to be charged by banks was again introduced effective March 15, 1976, and banks were also advised, for the first time, to charge interest on advances at periodic intervals, that is, at quarterly rests. In the following period, various sector-specific, programme-specific and purpose-specific interest rates were introduced.

1.2. Given the prevailing structure of lending rates of Scheduled Commercial Banks, as it had evolved over time, characterised by an excessive proliferation of rates, in September, 1990, a new structure of lending rates linking interest rates to the size of loan was prescribed which significantly reduced the multiplicity and complexity of interest rates. In the case of the Differential Rate of Interest Scheme under which credit was provided at a rate of 4.0 per cent per annum, and Export Credit, which was subject to an entirely different regime of lending rates supplemented by interest rate subsidies, the existing lending rate structure was continued.

1.3. An objective of financial sector reform has been to ensure that the financial repression inherent in administered interest rates is removed. Accordingly, in the context of granting greater functional autonomy to banks, effective October 18, 1994, it was decided to free the lending rates of scheduled commercial banks for credit Iimits of over Rs. 2 lakh; for loans up to Rs. 2 lakh, it was decided that it was necessary to continue to protect these borrowers by prescribing the lending rates and accordingly it was prescribed that for loans up to and inclusive of Rs.2 lakh, the lending rates of banks should not exceed the BPLR of the respective banks. For credit limits of over Rs.2 lakh, the prescription of minimum lending rate was abolished and banks were given the freedom to fix the lending rates for such credit limits subject to BPLR and spread guidelines. Banks were required to obtain the approval of their respective Boards for the Benchmark Prime Lending Rate (BPLR), which would be the reference rate for credit Iimits of over Rs.2 lakh. Each bank's BPLR has to be declared and be made uniformly applicable at all branches.

1.4  The BPLR system, introduced in 2003, fell short of its original objective of bringing transparency to lending rates. This was mainly because under the BPLR system, banks could lend below BPLR. For the same reason, it was also difficult to assess the transmission of policy rates of the Reserve Bank to lending rates of banks. Accordingly, based on the recommendations of the Working Group on Benchmark Prime Lending Rate which submitted its report in October 2009, banks have been  advised to switch over to  the  system of Base Rate with effect from July 1, 2010. The Base Rate system is aimed at enhancing transparency in lending rates of banks and enabling better assessment of transmission of monetary policy.

2. Guidelines

2.1. General

2.1.1. Banks should charge interest on loans / advances / cash credits / overdrafts or any other financial accommodation granted / provided / renewed by them or discount usance bills in accordance with the directives on interest rates on advances issued by Reserve Bank of India from time to time.

2.1.2. The interest at the specified rates should be charged at monthly rests (subject to the conditions laid down in paragraph 2.9) and rounded off to the nearest rupee.

2.1.3 The schedule of rates of interest as per the current directive in force is given in Annex 1.

2.2 Base Rate

2.2.1 The Base Rate system, as detailed below and in Annex 1 will replace the BPLR system with effect from July 1, 2010. For loans sanctioned up to June 30, 2010, BPLR will be applicable, as given in Annex 3 and 4. However, for those loans sanctioned up to June 30, 2010 which come up for renewal  from  July 1, 2010 onwards, Base Rate would be applicable. Base Rate shall include all those elements of the lending rates that are common across all categories of borrowers. Banks may choose any benchmark to arrive at the Base Rate for a specific tenor that may be disclosed transparently.  An illustration for computing the Base Rate is set out in Annex 2.  Banks are free to use any other methodology, as considered appropriate, provided it is consistent and is madeavailable for supervisory review/scrutiny, as and when required.

2.2.2 Banks may determine their actual lending rates on loans and advances with reference to the Base Rate and by including such other customer specific charges as considered appropriate.

2.2.3  In order to give banks some time to stabilize the system of Base Rate calculation, banks are permitted to change the benchmark and methodology any time during the initial six month period, i.e. end-December 2010.

2.2.4  The actual lending rates charged should be transparent and consistent and be madeavailable for supervisory review/scrutiny, as and when required.

2.2.5 There can be only one Base Rate for each bank. Banks have the freedom to choose any benchmark to arrive at a single Base Rate which should be disclosed transparently.

2.2.6 Even after introduction of the Base Rate system, banks would have the freedom to offer all categories of loans on fixed or floating rates. Where loans are offered on fixed rate basis, notwithstanding the quarterly review of the Base Rate, the rate of interest on fixed rate loans will continue to remain the same subject to  the  condition that such fixed rate should not be below the Base Rate.

2.3  Applicability of Base Rate

2.3.1 With effect from July 1, 2010, all categories of loans should be priced only with reference to the Base Rate.

2.3.1.1 However, the following categories of loans could be priced without reference to the Base Rate: (a) DRI advances (b) loans to banks’ own employees (c) loans to banks’ depositors against their own deposits.

2.3.1.2 In those cases where subvention is available to borrowers, it is clarified as under :

(i) Interest Rate Subvention on Crop Loans

(a) In case of crop loans up to Rupees three lakh, for which subvention is available, banks should charge farmers the interest rates as stipulated by the Government. If the yield to the bank (after including subvention) is lower than the Base Rate, such lending will not be construed to be violative of the Base Rate guidelines.

(b) As regards the rebate provided for prompt repayment, since it does not change the yield to the banks [mentioned at (a) above] on such loans, it would not be a factor in reckoning compliance with the Base Rate guidelines.

(ii)  Interest Rate Subvention on Export Credit

It has already been clarified, vide our circular DBOD.Dir.(Exp).BC.No.102/04.02.001/ 2009-10 dated May 6, 2010 that interest rates applicable for all tenors of rupee export credit advances will be at or above the Base Rate.  In cases where subvention is available in terms of our Circular DBOD.Dir.(Exp.).BC.No.94/04.02.001/2009-10 dated April 23, 2010, banks will have to reduce the interest rate chargeable to exporters as per Base Rate system by the amount of subvention available.  If, as a consequence, the interest rate charged to exporters goes below the Base Rate, such lending will not be construed to be violative of the Base Rate guidelines.

2.3.1.3 Restructured Loans

In case of Restructured loans if some of the WCTL, FITL, etc. need to be granted below the Base Rate for the purposes of viability and there are recompense etc. clauses, such lending will not be construed to be violative of the Base Rate guidelines.

2.3.2  The Base Rate could also serve as the reference benchmark rate for floating rate loan products, apart from external market benchmark rates. The floating interest rate based on external benchmarks should, however, be equal to or above the Base Rate at the time of sanction or renewal.

2.3.3  Changes in the Base Rate shall be applicable in respect of all existing loans linked to the Base Rate, in a transparent and non-discriminatory manner.

2.3.4  Since the Base Rate will be the minimum rate for all loans, banks are not permitted to resort to any lending below the Base Rate. Accordingly, the current stipulation of BPLR as the ceiling rate for loans up to Rs. 2 lakh stands withdrawn. It is expected that the above deregulation of lending rate will increase the credit flow to small borrowers at reasonable rate and  direct bank finance will provide effective competition to other forms of high cost credit.

2.3.5 Banks are required to review the Base Rate at least once in a quarter with the approval of the Board or the Asset Liability Management Committees (ALCOs) as per the bank’s practice. Since transparency in the pricing of lending products has been a key objective, banks are required to exhibit the information on their Base Rate at all branches and also on their websites. Changes in the Base Rate should also be conveyed to the general public from time to time through appropriate channels. Banks are required to provide information on the actual minimum and maximum lending rates to the Reserve Bank on a quarterly basis, as hitherto.

2.3.6 The Base Rate system would be applicable for all new loans and for those old loans that come up for renewal. Existing loans based on the BPLR system may run till their maturity. In case existing borrowers want to switch to the new system, before expiry of the existing contracts, an option may be given to them, on mutually agreed terms. Banks, however, should not charge any fee for such switch-over.

2.3.7 Interest rates under the BPLR system are applicable to all existing loans  sanctioned up to June 30, 2010.  However, wherever loans sanctioned up to June 30, 2010 come up for renewal  from July 1, 2010, the Base Rate system would be applicable. The guidelines on Benchmark Prime Lending Rate (BPLR) and Spreads and its determination for existing loans sanctioned up to June 30, 2010 are given in Annex 3 and Annex 4 .

2.4 Floating Rate of Interest on Loans

2.4.1. Banks have the freedom to offer all categories of loans on fixed or floating rates, subject to conformity to their Asset-Liability Management (ALM) guidelines. The methodology of computing the floating rates should be objective, transparent and mutually acceptable to counter parties. The Base Rate could also serve as the reference benchmark rate for floating rate loan products, apart from external market benchmark rates. The floating interest rate based on external benchmarks should, however, be equal to or above the Base Rate at the time of sanction or renewal. This methodology should be adopted for all new loans. In the case of existing loans of longer / fixed tenure, banks should reset the floating rates according to the above method at the time of review or renewal of loan accounts, after obtaining the consent of the concerned borrower/s.

2.5. Levying of penal rates of interest

Banks are permitted to formulate a transparent policy for charging penal interest with the approval of their Board of Directors. However, in the case of loans to borrowers under priority sector, no penal interest should be charged for loans up to Rs.25,000. Penal interest can be levied for reasons such as default in repayment, non-submission of financial statements, etc. However, the policy on penal interest should be governed by well-accepted principles of transparency, fairness, incentive to service the debt and due regard to genuine difficulties of customers.

2.6. Enabling clause in loan agreement

2.6.1. Banks should invariably incorporate the following proviso in the loan agreements in the case of all advances, including term loans, thereby enabling banks to charge the applicable interest rate in conformity with the directives issued by RBI from time to time.

"Provided that the interest payable by the borrower shall be subject to the changes in interest rates made by the Reserve Bank from time to time."

2.6.2. Since banks are bound by the Reserve Bank's directives on interest rates on loans and advances, which are issued under Sections 21 and 35A of the Banking Regulation Act, 1949, banks are obliged to give effect to any revision of interest rates whether upwards or downwards, on all the existing advances from the date that the directives / revised interest rate come into force, unless the directives specifically provide otherwise.

2.7. Withdrawals against uncleared effects

2.7.1. Where withdrawals are allowed against cheques sent for clearing, i.e. uncleared effects (e.g. uncleared local or outstation cheques) which are in the nature of unsecured advances, banks should charge interest on such drawals as per the directive on interest rates on advances.

2.7.2. As a measure of customer service, the above instruction will not apply to the facility afforded to depositors for immediate credits in respect of cheques sent for collection.

2.8. Loans under consortium arrangement

Banks need not charge a uniform rate of interest even under a consortium arrangement. Each member bank should charge rate of interest on the portion of the credit limits extended by it to the borrower, subject to the condition that such rate of interest is determined with reference to its Base Rate.

2.9. Charging of interest at monthly rests

2.9.1. Banks were required to switch-over to the system of charging interest at monthly rests with effect from April 1, 2002. While switching over to the new system, banks were required to ensure that the effective rate does not go up merely on account of the switch-over to the system of charging / compounding interest at monthly rests and increase the burden on the borrowers.

Illustratively

If a bank is charging in a borrower’s account an interest rate of 12 percent with quarterly rests, the effective rate is 12.55 percent. If the bank charges in the same account an interest rate of 12 percent at monthly rests, the effective rate comes to 12.68 percent. Banks should, therefore, adjust the 12 percent interest rate charged to the borrower in such a way that the effective interest rate to the borrower does not exceed 12.55 percent, as hitherto. Thus, in the above example, banks should charge interest at 11.88 percent (and not 12 percent). If this is done, the effective rate, even after compounding at monthly rests will be 12.55 percent.

2.9.2. Interest at monthly rests shall be applied in case of all new and existing term loans and other loans of longer / fixed tenor. In the case of existing loans of longer / fixed tenor, banks shall move over to application of interest at monthly rests at the time of review of terms and conditions or renewal of such loan accounts, or after obtaining consent from the borrower.

2.9.3. Instructions on charging interest at monthly rests shall not be applicable to agricultural advances and banks shall continue to follow the existing practice of charging / compounding of interest on agricultural advances linked to crop seasons. As indicated in circular RPCD.No.PLFS.BC.129/ 05.02.27/97-98 dated June 29, 1998, banks should charge interest on agricultural advances for long duration crops at annual rests. As regards other agricultural advances in respect of short duration crop and allied agricultural activities such as dairy, fishery, piggery, poultry, bee-keeping, etc., banks should take into consideration due dates fixed on the basis of fluidity with borrowers and harvesting / marketing season while charging interest and compounding the same if the loan / instalment becomes overdue. Further, banks should ensure that the total interest debited to an account should not exceed the principal amount in respect of short term advances granted to small and marginal farmers.

2.10. Zero percent Interest Finance Schemes for Consumer Durables

Banks should refrain from offering low / zero percent interest rates on consumer durable advances to borrowers through adjustment of discount available from manufacturers / dealers of consumer goods, since such loan schemes lack transparency in operations and distort pricing mechanism of loan products. These products do not also give a clear picture to the customers regarding the applicable interest rates. Banks should, also, not promote such schemes by releasing advertisement in different newspapers and media indicating that they are promoting / financing consumers under such schemes. They should also refrain from linking their names in any form / manner with any incentive-based advertisement where clarity regarding interest rate is absent.

2.11. Excessive interest charged by banks
           
2.11.1. Though interest rates have been deregulated, charging of interest beyond a certain level is seen to be usurious and can neither be sustainable nor be conforming to normal banking practice. Boards of banks have, therefore, been advised to lay out appropriate internal principles and procedures so that usurious interest, including processing and other charges, are not levied by them on loans and advances.  In laying down such principles and procedures in respect of small value loans, particularly, personal loans and such other loans of similar nature, banks should take into account, inter-alia, the following broad guidelines:

An appropriate prior-approval process should be prescribed for sanctioning such loans, which should take into account, among others, the cash flows of the prospective borrower.

Interest rates charged by banks, inter-alia, should incorporate risk premium as considered reasonable and justified having regard to the internal rating of the borrower. Further, in considering the question of risk, the presence or absence of security and the value thereof should be taken into account.

The total cost to the borrower, including interest and all other charges levied on a loan, should be justifiable having regard to the total cost incurred by the bank in extending the loan, which is sought to be defrayed and the extent of return that could be reasonably expected from the transaction.

An appropriate ceiling should be fixed on the interest, including processing and other charges that are levied on such loans, which should be suitably publicised.

Annex 1

Interest Rate Structure for all Rupee Advances including Term Loans of Commercial Banks from July 1, 2010 [paragraph 2.1.3]

1. All categories of loans will henceforth be priced only with reference to the Base Rate with effect from July 1, 2010.  However, the following categories of loans could be priced without reference to the Base Rate :

(a) DRI advances

(b) loans to banks’ own employees

(c) loans to banks’ depositors against their own deposits.

2. The Base Rate will be the minimum rate for all loans [except the exempted categories listed at 1.(a), (b) and (c) above] and banks will not be permitted to resort to any lending below the Base Rate.

3.

A . In those cases where subvention is available to borrowers, it is clarified as under :

(i)   Interest Rate Subvention on Crop Loans

a) In case of crop loans up to Rupees three lakh, for which subvention is available, banks should charge farmers the interest rates as stipulated by the Government. If the yield to the bank (after including subvention) is lower than the Base Rate, such lending will not be construed to be violative of the Base Rate guidelines.

b) As regards the rebate provided for prompt repayment, since it does not change the yield to the banks [mentioned at (a) above] on such loans, it would not be a factor in reckoning compliance with the Base Rate guidelines.

(ii)  Interest Rate Subvention on Export Credit

It has already been clarified, vide our circular DBOD.Dir.(Exp).BC.No.102/04.02.001/ 2009-10 dated May 6, 2010 that interest rates applicable for all tenors of rupee export credit advances will be at or above the Base Rate.  In cases where subvention is available in terms of our Circular DBOD.Dir.(Exp.).BC.No.94/04.02.001/2009-10 dated April 23, 2010, banks will have to reduce the interest rate chargeable to exporters as per Base Rate system by the amount of subvention available.  If, as a consequence, the interest rate charged to exporters goes below the Base Rate, such lending will not be construed to be violative of the Base Rate guidelines.

B. Restructured Loans

In case of Restructured loans if some of the WCTL, FITL, etc. need to be granted below the Base Rate for the purposes of viability and there are recompense etc. clauses, such lending will not be construed to be violative of the Base Rate guidelines.

4. There can be only one Base Rate for each bank. Banks have the freedom to choose any benchmark to arrive at a single Base Rate which should be disclosed transparently.

5. Even after introduction of the Base Rate system, banks would have the freedom to offer all categories of loans on fixed or floating rates. Where loans are offered on fixed rate basis, notwithstanding the quarterly review of the Base Rate, the rate of interest on fixed rate loans will continue to remain the same subject to  the  condition that such fixed rate should not be below the Base Rate.

ANNEX 5

List of circulars consolidated in the
Master Circular on 'Interest Rates on Advances'