The Hindu Business Line : Prime lending rate

Text-books define PLR or prime lending rate as the rate of interest at which banks lend to their credit-worthy or favoured customers. It is treated as a benchmark rate for most retail and term loans.

The RBI does not set these rates, but in a broad way stipulates the interest rates in the economy. The banks are at liberty to lend at a rate above or below the RBI’s.

The PLR is influenced by RBI’s policy rates — the repo rate and cash reserve ratio — apart from the bank’s policy. In simple words, availability of funds in the banking system and demand for credit by consumers (both retail and industrial) determine what the PLR should be.

Significance

Excessive money in the economy leads to inflationary trends. To control inflation, government may curb the money supply by increasing the lending rates or PLR. When RBI increases the PLR, banks may follow suit, making borrowing a costlier affair.

This hike in lending rates is bound to negatively impact businesses/industries which depend on banks for their working capital and expansion requirements.

The Indian picture

This is what has happened in India over the past year. A sharp rise in interest rates had taken its toll on liquidity and lead to a pause in economic growth.

A lowering of the CRR, the repo rate and the SLR (statutory liquidity ratio) at this juncture indicate the RBI’s urgency to infuse liquidity into the system. However, for the ultimate consumers to feel the ease, these steps have to be translated into trimmed down borrowing costs.

A lower rate increases liquidity by making all loans (fixed or floating) less expensive and, therefore, easier to access.

The effect of this is far-reaching and benefits corporate and retailers equally.

For example, take the case of any real estate player. Access to funds at cheaper rates reduces their working capital-requirements and encourages them to handle a larger number of projects. The common man, on the other hand, may find home loans and vehicle loans within reach at lower lending rates.

Lowering lending rates

Early this week, upon the request of the finance minister, public sector banks slashed their prime lending rates. Union Bank of India and Punjab National Bank, followed by SBI, Central Bank of India and Indian Bank have so far reduced their lending rates by 50-75 bps.

Private Banks, which usually lend at rates higher than the nationalised banks, are expected to follow suit. This cut reduces the cost of term loans for corporate houses. Normally, deposit rates follow lending rates.

When lending rates fall, one can expect a slash in deposit rates from banks too. So, risk-averse investors may soon have to look out for better return yielding investments, as bank deposits may lose sheen.

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