Base rate and interest rate effects

8/7/2019 Base rate and interest rate effects

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BASE RATE SYSTEM AND

EFFECTS OF CHANGE IN

INTEREST RATEBy: Azharuddin Mansiya


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AGENDA

What is base rate and why the move

Effect analysis of base rate system

Base rate calculation

Changing interest rates and risk premium

Short term impact on corporate borrowings

Overall change in investment activity


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BASE RATE

It is the minimum rate of interest that a bank is

allowed to charge from its customers.

BR came into effect from July 1, 2010. However

all existing loans continue to be at current rate. BPLR is the rate at which a bank is willing to

lend to its most trustworthy, low-risk customer


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INTEREST RATE INSENSITIVE BPLR

Source: CARE

BPLRs of public sector banks

have moved from a high of14.25% in Sep08 to 12.25% in

Mar10 and the BPLRs for

private sector banks moved from

15.75% to 14.75%.

The quantum of movement in

BPLR does not mirror the

changes in policy rates leading

to poor transmission of policyrates the BPLR of Public sector

banks changed by 200bps while

for their private counterparts

BPLR changed only by around

100bps.

This is despite the fact that the

deposit rates for Public sector

banks and private banks also

declined by 288bps and 200bps

respectively during the same

period


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EFFECT ANALYSIS OF BR

Transparency

Transmission of policy rates

Impact on Small borrowers

Rise in short term borrowing cost


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BASE RATE CALCULATION


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AN EXAMPLE OF BR

Base Rate 7.75%

Cost of deposits/funds 3.79%

Negative carry on CRR/SLR -0.90%

Unallocated Overheads 0.75%

Average return on Networth 1.14%


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INTEREST RATE AND RISK PREMIUM

Essentially, interest is

the price the borrower

pays and a return the

lender earns on his

funds.

Interest rates have an

indirect effect onequities.

When interest rates

move up, equities as

an asset class tend to

underperform and vice

versa.

This is essentially due

to risk premium,

which is the function

of risk free rate and

risk averseness of the

investors

Source: RBI and NSE


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HIGH AND LOW INTEREST RATE

ENVIRONMENT

Source: Reserve bank of India and NSE India

Source: Reserve bank of India and NSE India


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CORPORATE BORROWINGSCompanies borrowmainly to fund their

long-term expansion

plan and for their

annual capital

expenditure.

However there are

few expenses which

companies have to

fund on continuing

basis irrespective of

levels of interest

rates.

Hence some amount

of borrowing will

always be made to

fund continuing

operations like

working capital

requirements.

Source: Reserve Bank of India


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INVESTMENT ACTIVITY

Equities as an asset

class tend to

underperform when

interest rates increase.

Investors and market

participants are well

aware of this

correlation.

Looking at the data, it

is safe to say that when

interest rates are high,

investors prefer to trade

and invest in fixed

income money market

instruments over equity

stock markets and vice

versa

Source: Reserve Bank of India and SEBI


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Thank You

Base rate and interest rate effects

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