A Guide to the New Base Rate that Replaced Base Lending Rate

It is important for us to know first and foremost, what Base rate and Base Lending Rate (BLR) represents. Base Rate highlights a Bank’s judgment of the price of short-term funds on each currency’s interbank market.

The BLR, on the other hand, is relative to the financing needs of the private sector and deals with short and medium term financing needs. Depending on the creditworthiness of the borrowers and purpose for requesting a specific loan determines what percentage the BLR would be, and the rate differs from country to country.

The Base Rate and BLR structure in Malaysia

In January 2015, Malaysian Banks witnessed a change in the previous BLR structure, with which the Banks were accustomed with for a very long time. Under the previous framework, the BLR Rate was determined by the costs the Bank has to bear when lending money to different financial institutions and the Central Bank oversaw the costs of acquiring the necessary funds to lend to those financial institutions, adhering to the Overnight Policy Rate (OPR).

Now, there has been a shift of balance, in financial terms, the previous BLR framework has been completely modified to form a new Base Rate structure, and the individual Banks of Malaysia can now determine their interest rates based on the newly formed Base Rate structure and effective immediately, as this new Base rate framework will be followed by all the Banks.

Under the new Base Rate structure, the central bank has notified all the banks to adhere to the Statutory Reserve Requirement (SRR) when coming up with the interest rates, and the central bank has transferred the power to the individual banks to establish their own interest rates, which in turn will depend on each Bank’s cost to borrow money which will be used to lend loans.

A Wind of Change

Now that we have seen the change in the BLR framework, we have to look ahead and understand what kind of consequences or change this new framework will impose upon the economy in general, and how it will affect the general public in terms of their financial well-being.

The main rationale behind the makeover of the previous BLR structure was the lack of transparency and accountability of the Banks to the general people and lending out rates below the previous BLR set by the central bank to lure in more customers to facilitate a sharp increase in loan growth. Therefore, the new framework based on BR was introduced to encourage good transparency by the banks and has made it easier for the consumers to decide the most suitable packages.

Fiona Ho at iMoney wrote about this new framework in depth. The new Base Rate structure transfers the authority to each individual Bank to set individual Base Rates instead of the fixed rate set by the central bank under the previous framework, and it is based on the lending efficiency of each Bank.

This Base rate will be different from bank to bank and there will also be a minimum rate which the borrowers have to strictly keep in mind as they will not be able to borrow loans under this minimum Base Rate, which is also set differently by each bank. Banks which have a strong reputation and recognition for building their portfolio by focusing on customer financing, will seize this opportunity to offer attractive Base rates and lending rates to their consumer base to hold their competitive edge whilst making sure to cater to the needs of their strong customer base.

How does the Base Rate Framework Operates?

Let’s start with an example of the previous BLR structure which every Bank followed under the guidance of the central bank. If the existing BLR is, say 6.60% and the Bank sets its own mortgage interest at BLR-2.6%, then the actual interest rate (Or, Effective Lending Rate) a customer will have to pay for his/her loan is (6.60 – 2.60) = 4.60%.
Under the new Base Rate framework, the Banks have to display both their BLR and Base Rate to effectively determine the Effective Lending Rate (ELR) the borrower has to pay. This is because the customers who took up loan prior to Jan 2015, is still using BLR as a reference.

As we can see from the illustration below, Maybank has set its BR at 3.20% and interest rate at +1.35%, and so the ELR that a home loan borrower will have to pay now is 4.55%, which is slightly higher than the previous ELR under the BLR system that was in place prior to this January. So ultimately, there is not much of a difference between the two and the margin of change is minimal at best and will not make a significant impact on the borrower’s installments which he/she has to pay under the new Base Rate structure.

It is the ELR on which the home loan borrower’s will have to keep an eye on based on the different Base Rates that each of the Banks will set in order to uphold their competitive edge. The reason that the banks will have to exhibit both previous BLR and the current Base Rate is because existing loans which are already approved prior to January will follow the old BLR framework until the end of the loan’s term. The new framework unfortunately will have no impact on those thousands of existing home loan borrowers struggling to pay their mortgages.

The Implications of the New Base Rate Structure and its Impact on the General People

1. Greater Transparency – Under the new Base Rate Framework, the allocation of the costs of funds and other components have been laid out quite clearly for which the transparency and accountability of the Banks need to be increased. For the customers, better transparency will enable them to make better financial plans and choices when it comes to different loan packages offered by different banks at different Base Rates. Customers with bad credit history and low income will make the bank set the ELR higher and make more profits.

2. Changes in Cost from Monetary Policy – Due to the new Base Rate framework operating under the SRR guidelines, any Bank lacking liquidity, may raise the SRR to hold more money. However, this results in low loan growth as there are fewer funds to lend to potential borrowers as loans. The banks will have to monitor the change in Base Rates.

3. Increased Competition – To maintain transparency and a sharp competitive edge, some banks may prefer to lower the Base Rate than what is offered in other banks, and by doing so, they can offer lower ELR to their customers to facilitate higher loan growth. Also, because the Base Rate will be determined separately by individual banks, this will encourage the banks to plan attractive Base Rates for borrowers in order to achieve greater efficiency and a good credit rating for that particular banking institution.

This move will also stimulate the banks to look for more cost efficient ways to reduce operating costs and offer cost-efficient loan packages to stay in the competition. This means some Banks will be willing make less profits in order to stay in the competition, but smaller financial institutions cannot offer such competitive rates and therefore cannot compete with the bigger establishments in gaining more consumers to lend loans.

4. Negative Impact on the Home Loan Borrowers – As highlighted above, the new Base Rate system will not bring a significant change among the people paying mortgages for their homes due to the fact that the actual interest rates the borrowers have to pay will still remain pretty much the same, all thanks to the fact that the Banks can freely set the Base Rate. This new framework will not apply to the existing home loan borrowers. But if they want to refinance their homes or restructure their existing loans, these new loans will be rightfully processed against the new Base Rate. New applications for home loans will automatically be processed under the new BR structure and that includes Islamic loans as well.

References:
1. The Bank’s Base Rate
2. World Bank
3. iMoney – How Does Base Rate Work
4. LoanStreet – Base Rate
5. RinggitPlus – Base Rate