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The Reserve Bank on Monday asked banks to notify the base rate, or the minimum lending rate, at least once in every three months based on cost of funds, a move seen as a nudge to lenders to pass on changes in policy rate to borrowers.
The direction comes soon after Reserve Bank cut repo rate by 0.25 per cent, the first reduction in 20 months, to boost credit and economic growth.
Banks have in the past shown reluctance to pass on benefits of rate cut but have been proactive in raising benchmark lending rate soon after repo rate (the rate at which RBI lends to banks) is hiked.
At present, the review of the base rate does not have a fixed schedule.
"As hitherto, 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 Committee (ALCO) as per the bank's practice," said RBI's new guidelines on 'Interest Rates on Advances'. Banks will, however, not be allowed to change their methodology during the review cycle, RBI said.
New guidelines will come into effect from February 19.
"While computing Base Rate, banks will have the freedom to calculate cost of funds either on the basis of average cost of funds or on marginal cost of funds or any other methodology in vogue, which is reasonable and transparent provided it is consistent and made available for supervisory review/scrutiny as and when required," it said.
Further, RBI said it has been decided to allow banks to review the Base Rate methodology after three years from date of its finalization instead of the current periodicity of five years.
This has been done to provide banks greater operational flexibility.
"Accordingly, banks may change their Base Rate methodology after completion of prescribed period with the approval of their Board of Directors/ ALCO," it said.
On interest margins, the RBI said an existing borrower should not be charged extra except on account of deterioration in the credit risk profile of the customer or change in the tenor premium.