A "low interest" loan shouldn't mean you have very little interest in paying it back!
  • Conversion from Base Lending rate (BLR) to Base Rate (BR)

    Base rate of a bank is the reference rate at which it gives out floating rate loans to individuals. Whereas, the base lending rate (BLR) was a rate that determines the cost at which a bank lends funds to other financial institutions.

    BLR was set by Bank Negara Malaysia (BNM) before it was replaced by base rate in 2015. But before we discuss the new base rate working mechanism in detail, let’s see how BLR worked and why base rate took its place.

    BLR Mechanism

    Decided by BNM, BLR is the rate at which a bank lends funds to other financial institutions. The rate at which a bank borrows funds from other institutions was known as Overnight Policy Rate (OPR). But since it completely changed to base rate, banks can determine and set their own range of interest rates at which they can lend funds to other institutions as well as individuals. With the new base rate, BNM has transferred the power to banks and allowed them to establish their own range of interest rates.

    Base Rate

    The new base rate is determined by SRR (Statutory Reserve Requirement) and the benchmark COF (Cost of funds) of the financial institution. Base rate has introduced a new form of transparency in the process of borrowing and lending money in the form of loans. The new structure of base rate has transferred the authority to banks to set their base rates individually instead of BNM’s fixed rate. Base rate directly depends upon the lending efficiency of a particular bank or financial institution.

    How Does Base Rate Work

    The effective interest rate offered by a bank has two components: base rate and positive spread. This base rate is determined by the bank and can vary from institution to institution. Any change in a bank’s current base rate will reflect upon the effective rate of interest a loan is offered by the bank. Unlike the old structure of BLR, base rate tends to have more fluctuations as it depends directly on KLIBOR (Kuala Lumpur Interbank Offered Rate) and tends to change every 3 months. Although, the changes in base rates are not drastic.

    Components of the Spread

    The following are the components of the spread associated with an interest rate:

    • Liquidity risk premium
    • Borrower credit risk
    • Profit margin
    • Operating costs

    Implications of the New Base Rate Structure

    • Greater transparency to the customers: The new base rate has introduced a new layer of transparency to the loan process and the interest rates involved. Clearly laid out components make it easier for the customers to understand the basics of a loan they want. It becomes easier for them to check out all the loan options available in the market and find the one that suits their financial plans
    • A rise in the competition: The new base rate structure has also seen a rise in the market competition. The banks are offering an attractive range of floating rates based on their base rates in order to increase customer satisfaction level.
    • Fluctuations in the effective lending rate: Introduction of the new base rate is also triggering fluctuations in the effective interest rates at which a bank offers loans to its customers.
    • Impact on existing home loan borrowers: The new base rates do not apply to the existing home loans. So the customers having an existing home loan package will not benefit from the new base rate structure.

    Conclusion

    A well-structured and transparent base rate scheme is designed to suit loan needs of individuals as well as institutions. But it is prone to market fluctuations, so it is highly recommended that you explore your choices and research the market trends before deciding to apply for a loan.

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