Apprehensive that pricing loans to an external benchmark, rather than to their cost of funds, may affect their margins, lenders have expressed their reluctance at using these to price their loans. In communications to the Reserve Bank of India (RBI), several banks have said the external benchmarks suggested by the central bank would not be suitable for pricing loans. The central bank has, over the past couple of years, been trying to coax banks to lower lending rates. However, banks have been slow to do so citing the high cost of funds. Since January 2015, the RBI has trimmed the repo rate by about 200 basis points bringing it down to the current 6%. However, while the MCLR of marginal cost of funds-based lending rate has been lowered periodically, banks were slow to drop the base rates to which most loans were pegged. In recent months, though, loan rates have trended down consequent to deposit rates having been cut. “Linking lending rate to any of the external benchmarks as suggested by the internal study group (ISG) will add to volatility in margins and will place banks having vast branch networks, ATMs, business correspondents, at a competitive disadvantage,” State Bank of India (SBI) wrote in its letter.
For instance, the dependence of banks on repo funds was only marginal, the bank noted. Moreover, the rates on T-bills were a function of the government’s borrowing requirement and, therefore, highly sensitive to external environment/fiscal policies. As such, they did not represent banks’ marginal cost of funds. Also, the interest rates on certificates of deposit (CDs), the lender said, was not an active benchmark and besides, banks were not always raising resources via the CD route.
HDFC Bank noted that there was no correlation between cost of funds and any of the benchmarks proposed. “The linkage of lending rates to the proposed market benchmark will adversely impact banks,” the private sector lender said. It added that replacing the MCLR in such a short period of time would only add to the confusion among borrowers disrupting the market. The lender suggested the RBI improve the effectiveness of the MCLR system, instead. A clutch of bankers has written to the central bank requesting it to not mandate a migration from the current marginal cost of funds-based structure. Documents reviewed by FE under the Right to Information Act revealed banks have shared their concerns both via the Indian Banks’ Association as also in their individual capacities. The letters were sent in response to the RBI seeking comments on the report of an internal study group set up to review the working of the MCLR system. SBI added that the market-related benchmarks would impact the profitability of the banks and prompt them to recover a higher spread — over the benchmark — to cover their higher operating costs. Another private lender, Kotak Mahindra Bank wrote that migrating all existing loans to a new benchmark without any reference to the existing liability structure of banks and an embedded interest rate risk associated in such move could create an asset liability management risk.
“Any migration of existing loans to new benchmarks should be gradual and non-disruptive, over a period of time,” it added. ICICI Bank, which suggested that the MCLR system may be continued for pricing the incremental loans sanctioned or renewed, has said banks could “be allowed to migrate to external benchmarks in a phased manner and timeline for migration to new benchmarks (March 2019) may be evaluated”. Last year, the central bank had said said that an internal study group has observed that internal benchmarks such as the base rate/MCLR have not delivered effective transmission of monetary policy. The study group had pointed out that apart from arbitrariness in calculating the base rate/MCLR and spreads charged over them, the base rate/MCLR regime was also not in sync with global practices on pricing of loans. It had, therefore, recommended a switchover to an external benchmark in a time-bound manner. While the MCLR regime was introduced in April 2016 for better transmission of policy rates into bank lending rates, a large section of borrowers — existing borrowers — have been left untouched. The new regime was introduced only on fresh loans and existing borrowers have to pay a fee to move their loans from base rate to MCLR. It is estimated that around half of the total bank loans are yet to migrate to the MCLR system.