Explanation:
Base rate is decided in order to enhance transparency in the credit market and ensure that banks pass on the lower cost of funds to their customers. Loan pricing will be done by adding base rate and a suitable spread depending on the credit risk premium. While commercial banks are free to set their own interest rates for borrowing, the rates that they charge on loans and offer on savings tend to be derived from the base rate. This means that central banks can use base rates to encourage or discourage consumer spending,Example:
A large company might be charged, say, an interest rate of base rate plus 2% on a loan, whereas a smaller borrower might be charged, say, base rate plus 4%. Formerly, base rates were linked directly to BANK RATE but are now fixed by reference to the ‘official’ rate of interest set by the MONETARY POLICY COMMITTEE of the Bank of England.In a nutshell:
- Base rate is the minimum rate set by the Reserve Bank of India below which banks are not allowed to lend to its customers.
- Base rate is decided in order to enhance transparency in the credit market and ensure that banks pass on the lower cost of funds to their customers.
- Loan pricing will be done by adding base rate and a suitable spread depending on the credit risk premium.
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