rate with reference to a benchmark will make loan pricing fair, transparent and contestable. in the event, the bplr system failed to fulfil these objectives. 26. under the bplr system, banks were allowed to lend at rates below the bplr, but such lending was expected to be at the margin. however, in actual practice, banks started doing the bulk of their business below the bplr. in 2009, as much as 65 per cent of the advances were made at sub - bplr rates ; for private sector banks, the proportion was as high as 83 per cent. the lack of transparency in the system encouraged some perverse crosssubsidization. loans to priority sectors such as agriculture and sme sectors were overpriced so as to lend below the bplr to presumably preferred customers such as large corporates. the lack of transparency in the operation of the bplr also made it difficult to assess the effectiveness of monetary transmission from the policy rate of the reserve bank to lending rates by banks. 27. in order to correct the situation, the reserve bank appointed a committee under the chairmanship of deepak mohanty, executive director. as per the recommendations of the committee, the bplr system was replaced by a base rate system effective july 1, 2010. 28. under the new system, each bank is mandated to determine a base rate of interest to include those cost elements which can be clearly identified and are common across all borrowers – cost of deposits, cost of maintaining the statutory liquidity ratio and cash reserve ratio, cost of operations, and the profit margin. banks are allowed to determine the actual lending rate they charge on loans and advances by topping up the base rate with other customer specific charges such as product specific operating costs, credit risk premium and tenor premium. since the base rate is the minimum rate for all loans, banks are not permitted to do any lending below the base rate, save for specified exceptions such as dri advances, loans to banks ’ own employees, loans to banks ’ depositors against their own deposits and loans where borrowers enjoy subvention. as banks, in general, are not allowed to lend below the base rate, the stipulation of bplr as the ceiling rate for loans up to ₹200, 000 was rescinded in the expectation that with the freedom to determine the interest rate, banks will be encouraged to actively step into this large volume - low value business segment. 29. the base rate system is

intensification of financial market tensions, and its effects on the domestic components of inflation. if not contained by effective action by all policy - makers in the euro area, such intensification has the potential to affect the balance of risks on the downside. turning to the monetary analysis, recent data confirm the subdued underlying pace of monetary expansion. in august the annual growth rate of m3 decreased to 2. 9 %, from 3. 6 % in july. while this decline was mainly due to a base effect, monthly inflows were also relatively contained. conversely, strong monthly inflows into overnight deposits contributed to a further increase in the annual rate of growth of m1 to 5. 1 % in august, compared with 4. 5 % in july. this increase reflects a continuing high preference for liquidity in an environment of low interest rates and high uncertainty. the annual growth rate of loans to the private sector ( adjusted for loan sales and securitisation ) declined in august to – 0. 2 % ( from 0. 1 % in july ), reflecting a decrease in the annual rate of growth of loans to non - financial corporations to – 0. 5 %, from – 0. 2 % in july. by contrast, the annual growth of loans to households remained unchanged, at 1. 0 %, in august. to a large extent, subdued loan dynamics reflect the weak outlook for gdp, heightened risk aversion and the ongoing adjustment in the balance sheets of households and enterprises, all of which weigh on credit demand. at the same time, in a number of euro area countries, the segmentation of financial markets and capital constraints for banks restrict credit supply. the soundness of banks ’ balance sheets will be a key factor in facilitating both an appropriate provision of credit to the economy and the normalisation of all funding channels, thereby contributing to an adequate transmission of monetary policy to the financing conditions of the non - financial sectors in the different countries of the euro area. it is thus essential that the resilience of banks continues to be strengthened where needed. to sum up, the economic analysis indicates that price developments should remain in line with price stability over the medium term. a cross - check with the signals from the monetary analysis confirms this picture. other economic policy areas need to make substantial contributions to ensure a further stabilisation of financial markets and an improvement in the outlook for growth. as regards fiscal policies, euro area countries are progressing with consolidation. it is crucial that efforts are