RBI makes it mandatory for banks to link retail loans with external benchmarks from October 1

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Published: September 4, 2019 10:34 PM

In a circular issued on Wednesday, the Reserve Bank of India (RBI) said it has been observed that due to various reasons, the transmission of policy rate changes to the lending rate of banks under the current marginal cost of funds based lending rate (MCLR) framework has not been satisfactory.

RBI, retail loans, floating-rate loans for housing, MSME, MCLR, FBILIndustry and retail borrowers have been complaining that banks do not pass on the entire RBI’s policy rate (repo rate) reduction to them.

The RBI has made it mandatory for banks to link all new floating-rate loans for housing, auto and MSMEs to external benchmark like repo from October 1, a move aimed at ensuring faster transmission of policy rate cuts to borrowers. Industry and retail borrowers have been complaining that banks do not pass on the entire RBI’s policy rate (repo rate) reduction to them.

In a circular issued on Wednesday, the Reserve Bank of India (RBI) said it has been observed that due to various reasons, the transmission of policy rate changes to the lending rate of banks under the current marginal cost of funds based lending rate (MCLR) framework has not been satisfactory.

Therefore, it has now decided to make “it mandatory for banks to link all new floating rate personal or retail loans and floating rate loans to MSMEs (micro, small and medium enterprises) to an external benchmark effective October 1, 2019”, the circular said.

In 2019, the Reserve Bank has already reduced the repo or short-term lending rate by 110 basis points, but the banks have reportedly passed on only up to 40 bps to borrowers. The external benchmarks, to which the banks will be required to link their lending rates, could be repo, 3-month or 6-month treasury bill yield, or any other benchmark published by the Financial Benchmarks India Private Ltd (FBIL).

The banks have also been asked to reset the interest rate under external benchmark at least once in three months.
“In order to ensure transparency, standardisation, and ease of understanding of loan products by borrowers, a bank must adopt a uniform external benchmark within a loan category; in other words, the adoption of multiple benchmarks by the same bank is not allowed within a loan category,” the RBI added.

The circular further said while the banks are free to decide the spread over the external benchmark, the credit risk premium “may undergo change only” when borrower’s credit assessment undergoes a substantial change.Further, other components of spread including operating cost could be altered once in three years.

Existing loans and credit limits linked to the MCLR/Base Rate/BPLR shall continue till repayment or renewal, as the case may be. The decision of the RBI assumes significance amid clamour for reducing borrowing cost to push consumer demand, which is one of the major reasons for slowdown in the economy.

High frequency indicators like significant drop in auto sales and other consumer non-durable are pointing towards demand slowdown. The government has announced a slew of measures like liquidity support to the NBFC sector to further push credit disbursal.

The RBI had earlier asked the banks to link the rates to extrernal benchmark from April 1, but it was deferred as the lenders wanted more time. The State Bank of India had become the first bank to link its certain loans to repo. Later, a host of other banks too started linking their loan products to repo or other external benchmarks.

In August 2017, the RBI had constituted an Internal Study Group (ISG) to examine the working of the MCLR system that was put in place in April 2016. The ISG had recommended the move over to an external benchmark based lending rate system.

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