Replacing MCLR: Retail, MSE loans to be linked to external benchmarks

Updated: December 6, 2018 7:16 AM

Reserve Bank of India has proposed benchmarking of fresh floating rate personal or retail loans and loans to micro and small enterprises to an external benchmark, effective April 1, 2019

Replacing MCLR: Retail, MSE loans to be linked to external benchmarks

By Mitali Salian

In a move that could bring transparency, clarity on how banks price their loan products, the Reserve Bank of India (RBI) has proposed benchmarking of fresh floating rate personal or retail loans and loans to micro and small enterprises to an external benchmark, effective April 1, 2019.
Final guidelines on the same will be announced by the end of this month.

Karthik Srinivasan, group head of financial sector ratings at Icra, said in a note after the RBI announced it policy, “The proposal to link banks’ lending rates on new retail and MSME loans with external benchmarks is expected to improve the transparency in loan pricing by banks as the existing benchmarks, especially the base rate, have not led to a full transmission of the benefits of decline in cost of funds for banks’ to borrowers. Furthermore the profitability of banks may see a higher volatility, unless they are able to raise floating rate deposits linked to external benchmarks. On the other hand, for the borrowers, it may lead to a more frequent resets on their EMIs.”

Back in 2017, an internal study group chaired by Janak Raj that was constituted to study the various aspects of the Marginal Cost of Funds Based Lending Rate (MCLR) system noted that internal benchmarks such as the base rate or MCLR have not delivered effective transmission of monetary policy.
In keeping with suggestions from the group, the central bank has proposed options to link retail and MSE loans—namely, the policy repo rate or 91/182-day government treasury bill yield produced by the Financial Benchmarks India Private Ltd, or any other benchmark market interest rate produced by the FBIL.
However, it added, “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 catch , here, though is that banks are free to decide the spread over the benchmark rate at the inception of the loan, which should remain unchanged through the life of the loan. Unless the borrower’s credit assessment undergoes a substantial change and as agreed upon in the loan contract.
However, it is unclear whether the credit rating of the borrower will be determined internally or from an outside source. The RBI had in 2016 introduced the Marginal Cost of Funds based Lending Rates (MCLR) system on account of the limitations of the base rate regime. MCLR is linked to the actual deposit rates.

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