RBI to ‘formalise’ linking of loans to external benchmark

Mumbai: Linking of new loans to an external benchmark like the central bank’s repo rate will be formalised as an economic impetus is required not just from monetary policy assistance but also through transmission of rates, said Shaktikanta Das, governor Reserve Bank of India (RBI). Das, however, did not clarify if formalisation would mean that RBI will issue guidelines on this.

“I think the time has now come to formalise the linking of the lending rates on new loans to external benchmarks like the repo rate. We are monitoring the developments in this regard and whatever steps are required in the coming weeks, will be taken by RBI,” said Das, speaking at FIBAC, a banking conclave organised by the Indian Banks’ Association (IBA) and industry body FICCI.

In December, the central bank had said banks must set their interest rates for new loans against an external benchmark beginning 1 April. The new rule was supposed to apply to all new retail loans and small business loans with floating rates. However, the decision was met with a lot of resistance from bankers, who wrote to the regulator–then under the governorship of Urjit Patel–in 2018, citing concerns. Following which, in April, Das postponed the move and said RBI will hold consultations with stakeholders on it.

Currently, banks price their loans against their marginal cost of funds-based lending rates (MCLR).

“We have kept the external benchmark (guidelines) in abeyance because we wanted to see how the market evolves. It is a positive trend that the banks have responded but this process needs to be faster,” he said.

The governor said as against a repo rate cut of 75 bps by RBI (excluding the 35 bps cut in August) in 2019, the transmission was 29 bps and it was certainly not up to RBI’s expectations.

“It (transmission) should be, and can be better,” he said.

He added that since the last meeting of the monetary policy committee (MPC), many banks have announced initiatives to link their new loans to the repo rate.

“Our expectation is that they should move faster,” said Das. The RBI, he said, was constantly engaged with banks with regard to faster and greater transmission of monetary policy rates.

“The RBI will definitely pay its role as the regulator to work with the banks to see the trends in the market and take steps that can formalise these linking of new loans to repo rate or other external benchmarks,” he said.

The way banks set interest rates is critical for the smooth transmission of policy rates. To make this process transparent, RBI has, over the years, directed banks to price their loans against their benchmark prime lending rate (BPLR), base rate, and, finally, MCLR. Last year, though, was the first time that banks have been asked to price their loans against an external benchmark.