External Lending Benchmark May Make Loans Cheaper
The opprobrium did not inspire banks to bend. Time after time, the Reserve Bank of India (RBI) has plainly and severely expressed its displeasure on banks not passing on the policy benefits to customers, urging them to do so.
"Given the prevailing liquidity conditions and that we have reduced policy rates by substantial amount since the start of easing cycle, I think there is scope for banks to reduce lending rate for those segments. So far, they have not benefited to the full extent of our policy rate cuts," RBI Governor Urjit Patel said in August last year.
Now, banks may not be left with any scope to manoeuvre lending rates in their favour as a new benchmark to set rates may be put in place-- in a statement of December 5, the banking regulator said all banks should switch to one of the four market-linked lending benchmarks to provide personal & retails loans and loans given to micro and small enterprises. These could be repo rate or treasury bill yield or any other external benchmark market interest rate. The proposal was aimed at ensuring greater transparency in lending, the RBI said, adding final guidelines in this regard would be issued later this month.
In its annual report of 2017-18, the banking regulator had hinted at replacing the marginal cost of funds-based lending rate (MCLR) regime. An internal panel, set up by the RBI to examine various aspects of the MCLR system, had recommended linking of the bank lending rates to external benchmarks in September last year.
With an aim to improve policy transmission, the Reserve Bank in 2016 introduced the MCLR regime. The new lending benchmark replaced the previous base rate system which was operational since 2010. Prior to that, banks lent to customers using the Benchmark Prime Lending Rate (BPLR) system. These changes in lending benchmark were primarily meant to make sure borrowers were able to gain from policy changes announced by the central bank from periodically — the RBI announces changes in its monetary policy once in every two months. Quite like its predecessors, the MCLR system failed to help consumers.
"The experience with the MCLR system introduced in April 2016 for improving monetary transmission has not been entirely satisfactory," RBI Deputy Governor Viral Acharya told media after the RBI announced its third bi-monthly monetary policy review for 2017-18 on August 2.
It is also worth mentioning here that both the base rate system and the MCLR benchmark are not in line with global practices loan pricing.
Banks aligning loans to an external lending benchmark would mean benefits of policy changes will quickly reach to borrowers. As against the current system of annual reset of interest rates, rates be reset every quarter. Financial institutions would have the freedom to decide on the spread over the external benchmark. This spread would be fixed through the term of the loan.
Want to know what spread is? Read this.
Between September 2016 and 2017, overnight MCLR rates have come down to 8.10 per cent from 9.15 per cent. In the same period, 91-day treasury bill rates have fallen to 6.11 per cent from 6.52 per cent while the repo rate has come down to 6 per cent from 6.5 per cent.
"We think that the internal benchmark such as the base rate or MCLR seems to give banks a very high amount of discretion. A lot of factors give them the flexibility to keep lending rates high even if the monetary policy rates are going down and are on (an) accommodative path,” Acharya told media after the fourth bi-monthly monetary policy was announced on October 4 last year.
“To address this, we think it's time to move to what most countries follow — to have these rates tied to external benchmarks, which will create transparency for borrowers. They can just compare two loans and see which is at a lower spread because the benchmark would be the same," Acharya added.
The committee report had proposed that all borrowers be migrated to the new system by March 2019 without a switchover fee. It is worth mentioning here that a large number of existing borrowers still have their loans linked to the previous base rate regime.