RBI Makes it Mandatory for Banks for Linking the Retail Loans with External Benchmarks from 1st October

RBI Makes it Mandatory for Banks for Linking the Retail Loans with External Benchmarks from 1st October

The RBI has made it compulsory for banks for linking all new floating-rate loans for housing, auto as well as MSMEs to an external benchmark like repo from 1st October, a move intended at certifying faster transmission of policy rate cuts towards borrowers.

Towards being sure, banks have already started linking their lending rates towards an external benchmark. Amongst these are public sector lenders State Bank of India, Union Bank of India, Central Bank of India, Punjab National Bank as well as private sector lender Federal Bank. Other banks commonly price loans under the marginal cost of funds-based lending rate (MCLR).

The industry and retail borrowers were complaining that banks do not pass on the whole RBI's policy rate (repo rate) reduction to them.

In a recently issued circular, the Reserve Bank of India (RBI) stated it has observed that because of many reasons, the transmission of policy rate changes towards the lending rate of banks under the current marginal cost of funds based lending rate (MCLR) framework was not satisfactory.

Thus, it has now decided for making it compulsory for banks towards linking all-new floating rates personal or retail loans and floating rate loans to MSMEs (micro, small and medium enterprises) towards an external benchmark effective from 1st October 2019.

The RBI has stated that the existing loans and credit limits linked towards the MCLR/base rate/BPLR shall continue till repayment or renewal Interest rate under external benchmark would be reset at least once in 3 months.

As per RBI, banks are free to choose one of the several benchmarks. Though, a lender cannot accept multiple benchmarks within a loan category. 

Banks are also allowed towards selecting their spread over the benchmark rate, subjected to the condition that the credit risk premium might go through changes only when borrower’s credit assessment undergoes a substantial change, as settled upon in the loan contract.

In the previous month, RBI has lowered its benchmark interest rates for a 4th straight time with a slightly bigger-than-expected 35 basis points cut. 

All new retail and MSME loans would be linked to one of the following benchmarks: 

•    Reserve Bank of India policy repo rate
•    Government of India 3-months Treasury Bill yield published through the Financial Benchmarks India

•    Government of India 6-months Treasury Bill yield published through the FBIL
•    Any other benchmark market interest rate published through the FBIL.

In 2019, the Reserve Bank had already reduced the repo or short-term lending rate through 110 basis points, but the banks have reportedly passed on only up to 40 bps towards borrowers.

The external benchmarks, towards which the banks shall be requisite to link their lending rates, can be repo, 3-month or 6-month Treasury bill yield, or any other benchmark published through the Financial Benchmarks India Private Ltd (FBIL).

The banks were asked to reset the interest rate under the external benchmark at least once in 3 months.

The RBI also stated that with the intention of ensuring transparency, standardization, and easiness of understanding of loan products through borrowers, a bank should adopt a uniform external benchmark within a loan category; basically, the adoption of multiple benchmarks through the same bank is not allowed within a loan category.

The circular additionally stated that though the banks are allowed to select the spread over the external benchmark, the credit risk premium "might undergo change only" when borrower's credit assessment go through a substantial change.

Also, other components of spread comprising operating cost can be altered once in 3 years.

The resolution of the RBI undertakes significance amongst the clamour for reducing borrowing cost in order to push consumer demand, which is one of the main reasons for the slowdown in the economy.

High-frequency pointers like a significant drop in auto sales as well as other consumer non-durable are pointing towards demand slowdown.

The government has stated a slew of measures like liquidity support towards the NBFC sector to further push credit disbursal.

The RBI had previously asked the banks to link the rates towards external benchmark from 1dt April, but it was delayed as the lenders wanted more time.

The State Bank of India was the first bank to link its certain loans to the repo. Later, a host of other banks also started linking their loan products towards the repo or other external benchmarks.

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

eStartIndia is the professional tech-based online and legal services provider which help the clients to simplify the procedures of all kinds of registration, implementation, tax concerns and any additional legal compliances and services related to the business in India.


eStartIndia Team

Leave a Comment

Previous Comments

Related Blogs