The Reserve Bank of India (RBI) on Wednesday made it mandatory for all banks to link floating rate loans — to retail customers and loans to micro, small and medium enterprises (MSME) — to an external benchmark. Some banks have already started to link home and auto loan rates to the repo rate, which is an external benchmark.
The move is aimed at faster transmission of monetary policy rates. Banks have been reluctant to cut interest rates despite the RBI lowering the repo rate by 110 basis points (bps) between February and August.
“It has been observed that due to various reasons, the transmission of policy rate changes to the lending rate of banks under the current MCLR framework has not been satisfactory,” the banking regulator said while announcing the new norms.
“The RBI, therefore, has issued a circular making it mandatory for banks to link all new floating rate personal or retail loans and floating rate loans to MSMEs to an external benchmark effective October 1, 2019.”
The norms for external benchmark linking of interest rates was scheduled to be operational from April 1, but was deferred. At present, interest rates on loans are linked to a bank’s marginal cost of fund-based interest rate (MCLR). Banks can choose from one of the four external benchmarks — repo rate, three-month treasury bill yield, six-month treasury bill yield or any other benchmark interest rate published by Financial Benchmarks India Private Ltd.
“Adoption of multiple benchmarks by the same bank is not allowed within a loan category,” the RBI said.
While banks are free to decide on the spread over the external benchmark, credit risk premium can change only when borrower’s credit assessment undergoes a substantial change, the RBI said, adding other components of spread, including operating cost, could be altered once in three years. “The interest rate under external benchmark shall be reset at least once in three months,” RBI said. Existing loans and credit limits linked to the MCLR, base rate or BPLR, would continue till repayment or renewal, RBI said.
Regarding transition to external benchmark from MCLR for existing customers, RBI said floating rate term loans sanctioned to borrowers eligible to prepay the loan without pre-payment charges, will be eligible for switch-over to the external benchmark without any charges, except for reasonable administrative/ legal costs. “The final rate charged to this category of borrowers, post switchover to external benchmark, shall be the same as the rate charged for a new loan of the same category, type, tenor and amount, at the time of origination of the loan,” RBI said.
‘Good move’
“It is a good move from the RBI… they were hinting at this for sometime. Banks are well-prepared to launch the products,” Union Bank of India MD & CEO Rajkiran Rai. G told The Hindu . Union Bank has already linked some of the floating rate products to repo rate. Mr. Rai indicated that deposit rates could also be linked to an external benchmark at a later stage.
“First, we will try to link the savings bank interest rate and then gradually we will try to introduce some term deposit products so that the transmission of the rates are equal on both sides,” he said.
