Money & Banking

RBI asks banks to link interest rates to external benchmark

Our Bureau Mumbai | Updated on September 04, 2019 Published on September 04, 2019

New rule covers floating rate loans to retail, personal, MSME customers from Oct

Home and auto loans could get cheaper in the festival season. In a bid to address concerns over the transmission of rate cuts, the RBI has made it mandatory for banks to link all new floating rate loans with an external benchmark from October 1.

The new rule will be applicable to floating rate loans to retail, personal and MSME borrowers but banks are free to offer such external benchmark-linked loans to other types of borrowers as well.

Banks will have an option to benchmark the loans either to the RBI policy repo rate, Government of India three months or six months Treasury Bill yield or any other benchmark market interest rate published by the Financial Benchmarks India Pvt Ltd.

“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 RBI said in a statement on Wednesday.

The RBI directive comes at a time when, despite four cuts in key policy rates totalling 110 basis points in 2019, banks have been slow to follow suit. The repo rate now stands at 5.4 per cent but loans to borrowers have not reflected this despite nudges by the Finance Ministry and the RBI. The government, which has been trying to address the slowdown in the economy, has been keen for an uptick in consumption and demand.

As part of the first set of stimulus measures announced on August 23, Finance Minister Nirmala Sitharaman had promised that EMIs and loans would become cheaper as public sector banks would soon start lending at RBI’s benchmark linked rates.

In the last few weeks, a number of public sector banks have linked some loans to the repo rate but private sector banks have largely shied away.

“I think the time has now come to formalise this linking of new loans to external benchmarks like repo rate. We are monitoring this and will be initiating necessary steps,” RBI Governor Shaktikanta Das had said last month at the annual banking conference - FIBAC in mid -August.

The RBI circular said banks will be free to decide the spread over the external benchmark but the credit risk premium can be changed only when the borrower’s credit assessment changes substantially. Other components of spread including operating cost can be altered once in three years. The interest rate under the external benchmark shall be reset at least once in three months.

VG Kannan, Chief Executive of the Indian Banks’ Association, said customers will benefit from the move. “(But) for bankers, the net interest margins will get impacted and may shrink as there will be no link to the cost of funds,” he said.

Existing loans and credit limits linked to the MCLR, Base Rate, BPLR shall continue till repayment or renewal but borrowers who are eligible to prepay a floating rate loan without pre-payment charges, shall be eligible for switch-over to External Benchmark without significant fees.

Other existing borrowers will also have the option to move to External Benchmark at mutually acceptable terms, the RBI said, adding that the switch-over will not be treated as a foreclosure of existing facility.

The RBI had in December last year as part of the fifth bi-monthly monetary policy of 2018-19 announced that all new floating rate personal or retail loans and floating rate loans to micro and small enterprises from April 1, 2019 would be linked to external benchmarks. But later, in April in the first bi-monthly MPC for 2019-20, the plan was deferred.

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Published on September 04, 2019
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