Concept of BRR or, Base Rate Regime

Concept of BRR or, Base Rate Regime

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In the Base Rate Regime of lending rates, the Reserve Bank of India instructed banks to adhere to a number of parameters before determining the BRR or, the base rate lending rates. At all costs, the lending rate ought to be lower than this base rate. The RBI believes that this will eliminate the PLR-based interest rate regime's mismatch. The following are the RBI-set parameters.

1. Cost of Funds (COF) - Banks typically borrow money from the RBI, private individuals, and businesses. Consequently, banks are required to charge a certain interest rate on deposits once they borrow money from these organizations, right? Therefore, if your bank offers you a FD interest rate of 7%, the bank must take this cost into account when determining the lending rate.

2. Operational Expenses (OE) - A bank will incur certain costs whenever it lends money to a borrower or collects money from depositors. Naturally, the borrower must bear these costs, which should be included in the lending rate.

3. Cost of CRR (the Cash Reserve Ratio that banks keep with the RBI) - Let's say the bank got Rs. 100 billion from the customer. In the world of finance, this is referred to as the CRR, or Cash Reserve Ratio, and the bank is required by RBI guidelines to keep a portion of this with the RBI. Let's say this is about 4%. Therefore, the bank must deposit Rs.4 crore with the RBI if it received Rs.100 crore from depositors. The RBI's Rs. 4 billion will not generate any interest for the Bank. because the RBI will not pay CRR any interest. Therefore, if the Bank promised to provide individuals with an interest rate of 7% in exchange for collecting Rs. 100 crore, this IDLE cost of Rs. 4 crore with the RBI is also the Bank's expense. The bank must pay the depositor this 7% interest out of its own pocket. Cost of CRR is the name for this. As a result, the RBI's guidelines included taking this Cost of CRR into account when determining the lending rate.

4. The profit margin - After taking into account the aforementioned costs, the bank must ultimately function as a business, right? Consequently, they need to consider what edge of benefit they are checking in their business out. The lending rate also includes this profit margin.

Under the Base Rate Regime (BRR), banks used a combination of all four parameters to set their lending rates. Therefore, the lending should not be at any cost below this base rate, in accordance with RBI guidelines. Keep in mind that banks were permitted to charge an additional interest rate in addition to the base rate. SPREAD or PREMIUM are the names given to this additional rate. This is typically lower for borrowers with high credit scores and evidently higher for borrowers with lower credit scores. The fact that a bank providing a loan to an individual is distinct from one providing a loan to a business entity necessitates the introduction of the spread or premium. Thus, banks can set their spread or premium to the borrower based on the risk of lending.