Banks and non-banking financial companies are seeking greater flexibility in determining lending rates under the Reserve Bank of India’s (RBI’s) proposed interest-rate framework, saying differences in funding costs, operating expenses and borrower risk profiles make it difficult to standardise pricing.

“We are still evaluating. But what we can see is that some leeway should be given to banks to determine these figures. Tell us the broad controls, because spread and benchmark is something that is flexible, it cannot be rigid,” a bank chief financial officer said.

On Wednesday, the RBI proposed a rationalised framework for interest rates on loans and advances, tightening norms for floating-rate loans to improve transparency. It said regulated entities should determine lending rates with reference to an internal or external benchmark plus a risk-based spread. The proposed framework specifies that the spread may comprise a credit-risk premium, operating costs, a term premium and a business-strategy premium.

“With respect to commercial banks, divergent practices have been observed in certain aspects, including determination of MCLR (internal benchmark) and its components,” the RBI said in the draft.

Under the proposed norms, interest on advances would be charged with monthly rests, except for agricultural and farmer advances, where interest would be computed based on crop duration. Interest would also be calculated on a daily reducing-balance basis.

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A chief financial officer of a mid-sized NBFC said the framework could be difficult to implement as lenders have different cost structures and risk profiles.

“Everyone operates in a different risk-reward environment. Somebody who has operating cost of 2% and somebody who is operating at 8%, the end-user rate cannot be the same,” he said.

He added that smaller lenders could be particularly affected because their funding costs can be higher than those of large banks. The proposed framework, he said, could make lending to higher-risk borrowers less viable and put smaller players at a disadvantage.

Sachin Sachdeva, vice-president, financial sector ratings, ICRA, said the proposed framework would reduce the flexibility available to regulated entities in interest-rate reset periodicity and spread adjustments.

“Consequently, lenders may face increased margin pressures particularly during periods of monetary easing as the yields would soften faster than funding costs. Further, restrictions on spread adjustment could constrain pricing flexibility and impact overall earnings profile,” he said.

According to a report by Motilal Oswal, public sector banks (PSBs) had seen slower transmission of rate cuts in earlier repo cycles as their MCLR repricing was weaker than that of private banks. However, the draft norms, which require quicker MCLR resets and faster pass-through of changes in deposit rates to lending rates, are expected to narrow this gap, even though PSBs have a larger MCLR-linked loan book.

“In the long run regulations to narrow the difference in NIM performance across private banks and PSBs (public sector banks) though MCLR repricing will still depend on the extent of reduction in deposits / borrowing cost which has lower repo rate sensitivity,” the report said.

Analysts said the draft’s push for greater transparency in how NBFCs calculate their internal benchmarks was a positive step. NBFCs currently have limited disclosure on the methodology used to arrive at their benchmarks. Requiring board-approved policies to be documented and disclosed would allow borrowers to better understand the components of lending rates, they said.

The proposed framework could also accelerate monetary policy transmission. “The proposed interest rate reset framework is likely to materially improve the pace of monetary policy transmission by ensuring that lending rates across banks and non-banking financial companies change faster with the changes in policy rates,” Sachdeva said.

The draft also requires regulated entities to put a ceiling on the annual percentage rate (APR), including interest and all other charges and fees, for microfinance and small-value loans. For lenders focused on small-ticket and microfinance loans, the proposed ceiling could put pressure on profitability.

“The APR ceiling will cap yields for lenders reliant on high-yield small-ticket lending. However, the transition deadline of April 29 provides adequate runway,” said Saurabh Bhalerao, director, CareEdge Ratings.

The proposed directions are to take effect from April 1, 2027, while existing loans linked to internal or external benchmarks would have to be migrated to the new framework by April 1, 2029. The RBI has sought comments on the draft guidelines by September 11.