"I realise that some of my criticisms may be mistaken; but to refuse to criticize judgements for fear of being mistaken is to abandon criticism altogether... If any of my criticisms are found to be correct, the cause is served; and if any are found to be incorrect the very process of finding out my mistakes must lead to the discovery of the right reasons, or better reasons than I have been able to give, and the cause is served just as well." -Mr. HM Seervai, Preface to the 1st ed., Constitutional Law of India.

Tuesday, June 29, 2010

Interest Rate Indexing in Commercial Contracts: Part I

Often, in many commercial contracts in India, the interest rate (especially for delay in payment under the contract or the rate of interest in the arbitral award) is linked to the Benchmark Prime Lending Rate (BPLR) of the State Bank of India (SBIPLR or SBAR).  These rates are chiefly used in loan agreements between businesses and banks. In international transactions, contract interest rates are usually linked to LIBOR. Recently, there has been a new development regarding BPLR, which has necessitated discussion on this topic.

In case  you are a student, we suggest you request your banking law lecturer to teach about interest rate indexes, LIBOR and BPLR because if you plan to become a business lawyer, whether as a teacher or a transactional lawyer or an advocate, you would necessarily be dealing with these aspects in one form or the other. The objective of this post is to introduce and discuss the notion of BPLR. In the next post in this series, we would be discussing the topic's current relevance. We would also  give links at the end of the next post to resources in case you want to have a deeper knowledge on this subject.

PLR and its Evolution:
Prime Lending Rate is the interest rate which a bank charges for loans to its most creditworthy borrowers. Section 4 of the Interest on Delayed Payments to Small Scale and Ancillary Industrial Undertakings Act, 1993 defines PLR in respect of SBI to mean "the Prime Lending Rate of the Stale Bank of India which is available to the best borrowers of the bank."

Many news paper editorials and other articles in the internet define BPLR to be the interest rate which bank charges for its most creditworthy borrowers. But defining BPLR as such is to ignore certain historical developments which we are noted below.

Prior to October 1994, interest rate on lending was heavily regulated. In October 1994, the lending rates were significantly deregulated: Banks could determine the lending rates for loans over Rs. 2 lakhs. However, the banks were also required to declare their prime lending rate, determined after approval of their board of directors. For loans above Rs. 2 lakhs, the PLR acted as the floor rate (minimum rate). In 1997, banks were allowed to charge PLR independent of each other. In April 1998 of the same year, for loans upto Rs. 2 lakhs, PLR was made the ceiling rate.  For loans in certain categories, banks were allowed to charge interest rate independent of PLR.

In the Statement by the Governer of the RBI on Monetary and Credit Policy for 2001-2002  (19 April 2001), Dr. Bimal Jalan noted that there were requests from bankers that the PLR should be mae a benchmark rate instead of making it a floor rate. The Governer noted that Sub-PLR loans were becoming common in the international arena, though the traditional view was that PLR should be the floor rate for loans for teh highest credit worthy borrowers. Dr. Jalan declared:

"83. Keeping in view the international practice and to provide further operational flexibility to commercial banks in deciding their lending rates, it has been decided to relax the requirement of PLR being the floor rate for loans above Rs.2 lakh. Banks will be able to offer loans at below-PLR rates to exporters or other creditworthy borrowers including public enterprises on the lines of a transparent and objective policy approved by their Boards."
However, the policy of PLR being the ceiling rate for below Rs. 2 lakh loans continued. 2002 was the year in which the RBI got serious about monitoring of lending rates and required banks to furnish information on the lending rates. The PLR of different banks varied widely. Hence, in his Statement on Monetary and Credit Policy 2003-2004 (29 April 2003), the Governer of the RBI advised the banks to announce a Benchmark Prime Lending Rate.(BPLR) with the approval of their boards. In calculating the BPLR, the banks were advised to take into consideration:
  1. actual cost of funds,
  2. operating expenses and
  3. a minimum margin to cover regulatory requirement of provisioning/capital charge and profit margin.
 The purpose of this recommendation was to ensure that PLR of banks tends towards the actual cost of lending. Pursuant to this, the IBA [Indian Banks Association] issued detailed guidelines in November 2003 [I tried to find this circular in the internet but could not. In case anyone has a copy, kindly share it with us.] on the determination of the BPLR. The Report of the Working Group on BPLR (October 2009) observes, on the difference in purpose of the PLR and the BPLR:

"The BPLR system was expected to be a step forward from the PLR system, which more or less represented the minimum lending rates, to that of one which stood as a benchmark or a refernce rate around which most of the banks' lending was expected to take place."

For now, readers can check out this page of Indian Banks Association for BPLRs of various banks. More on this topic in a subsequent post.

1 comment:

R. Ramesh said...

hey blogging is good of course..otherwise i d not have come across a good person and friend like u...cheers n wishes always:)