The base rate is the minimum lending rate that a bank sets — it cannot lend to any customer below this rate (except in certain government-mandated schemes). It creates a transparent floor for loan pricing and ensures banks do not offer unfairly low rates to favored borrowers.
Banks calculate their base rate using factors like the cost of deposits, operating expenses, profit margin, and statutory reserve costs. If a bank's base rate is 8%, a home loan might be priced at base rate + 0.5% = 8.5%, while a personal loan might be base rate + 4% = 12%.
In India, the RBI replaced the base rate system with the MCLR (Marginal Cost of Funds based Lending Rate) in 2016 and later introduced the External Benchmark Lending Rate (EBLR) linked to the repo rate. These reforms ensure that changes in the central bank's policy rate are quickly passed on to borrowers.