Delay ushering in new floating rate lending regime: Banks to RBI

Banks have requested the Reserve Bank of India to delay ushering in the new floating rate lending regime, which is linked to one of the four RBI-prescribed external benchmarks, and expected to come into effect from April 1, 2019. This is possibly due to fear of an adverse impact on their net interest margins at a time when they are grappling with bad loans and attendant provisions.

The external benchmarks to which banks’ lending rates will be linked are: policy repo rate, or 91-day Treasury Bill yield, or 182-day Treasury Bill yield, or any other benchmark market interest rate produced by the Financial Benchmarks India Private Ltd (FBIL).

In its Statement on Developmental and Regulatory Policies, issued along with the fifth bi-monthly monetary policy statement in December 2018, the RBI proposed that all new floating rate personal, or retail loans, and floating rate loans to micro and small enterprises extended by banks from April 1, 2019, will be benchmarked to one of the four above-mentioned benchmarks.

The RBI wants to usher in the external-benchmark-based lending regime as the transmission from the changes in the policy repo rate has been slow and incomplete under the earlier base rate and the extant marginal cost of funds-based lending rate (MCLR) systems.

“We want the MCLR, which was introduced with effect from April 1, 2016, to continue. Linking lending rates to an external benchmark is not required immediately. Monetary policy transmission is happening through the MCLR. It was introduced only a couple of years back. Let it settle down. We have conveyed our views to the central bank,” said a senior public sector bank official.

NIM to be affected

BK Divakara, former Executive Director of Central Bank of India, said that bankers’ apprehension on the new floating rate lending regime could stem from the fact that interest rates on loans that have been granted will move more dynamically with the external benchmark, whereas deposits will continue at the old contractual rates. To that extent, banks’ net interest margins (NIMs) will get affected.

According to an RBI working paper, a bank with high NIM is considered more efficient, compared to a bank with low NIM since high NIM can raise profitability.

After the asset-quality review undertaken by the RBI in 2015, for clean and fully provisioned balance sheets, NIMs of banks, especially PSBs, have been under pressure, as many stressed loans were recognised as non-performing assets and stopped earning interest.

Kotak Securities, in a recent report, observed that the key concerns with respect to the implementation of external-benchmark-based loan pricing include greater volatility in spreads, likelihood of NIM coming under sharp pressure during declining interest rates for low-spread products such as housing loans, and a fixed cost liability franchise resulting in banks lowering the duration to reduce volatility of NIM.

The report said the ability of banks to address this risk is not clear as they would need (a) retail floating rate deposits, and (b) interest rate hedging products.

Banks are awaiting the final guidelines on the external-benchmark-based lending regime, which, as per the Statement on Developmental and Regulatory Policies, were to be issued by the end of December 2018.

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