Optimality Of Base Rate System Of Loan Pricing Of A Developing And Emerging Market Economy: An Evaluation

Jugnu Ansari and Ashima Goyal

Working Papers from Centre for Advanced Financial Research and Learning (CAFRAL)

Abstract: This paper provides an analytical assessment of the Base Rate loan pricing rule by the commercial banks in a regulated environment that could relate to some developing and emerging market economies. The study found that the Base Rate approach to loan interest rate has an inbuilt upward bias due to specification of short-term yield on investment in government securities and measurement of overhead cost charge for loans. The upward bias in the base rate could be in the range 150 to 300 basis points. From policy perspective, the base rate due to its upward bias could impose a sub-optimal and excess loan pricing structure on the banking system. Therefore, countries which have adopted the system of Base Rate may benefit from a critical review of such loan pricing regulation for the purpose of macroeconomic and financial system stability.

Keywords: Base rate, interest rate pass-through; bank competition; Monetary Policy Transmission (search for similar items in EconPapers)
JEL-codes: C23 D4 E43 E52 G21 L10 (search for similar items in EconPapers)
Pages: 21
Date: 2014-06
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