Link lending rates of loans to repo rates, says RBI to lenders

The Reserve Bank of India (RBI) has proposed implementation of external benchmarking on the bank loans with repo rate or T-bills. This proposal aims at accelerating the economic growth of the country and improving the transmission of policy rates.

The RBI Governor, Shaktikanta Das, said that the time has come to formalise the linking of lending rates of new loans to external benchmarks like the repo rate. He did not mention whether the Central Bank would issue guidelines for such formalisation or not. 

Currently, the loan rates are based on internal benchmarks like base rate, the marginal cost of funds-based lending rate (MCLR), and benchmark prime lending rate (BPLR). In December 2018, the RBI asked the banks to set their interest rates for new retail loans against the external benchmark, beginning April 1, 2019.

This plan of the Central Bank to implement external benchmarking was deferred after the sudden exit of the former governor of the Central Bank, Urijit Patel. The move to ensure better and faster transmission of the policy rate by banks did not have the intended effect. 

While the key policy rate of RBI was brought down by 110 basis points (bps), the banks only transmitted 29 bps between February and June on fresh rupee loans. On this comparison, Das said the transmission should be better and faster. 

Also Read: RBI slashes repo rate to improve economy output and boost consumption

Several banks have announced initiatives to link their retail loans with an external benchmark i.e. repo rate. The country biggest lender, State Bank of India (SBI) was the first to link its loan rates to repo rates. It linked its savings account with a balance of more than Rs 1 lakh to the RBI’s repo rate. Also, SBI linked its working capital loans to the policy benchmark.

At the same time, many lenders introduced repo rate-linked home loans. The same was followed by Bank of Baroda and Union Bank. However, this will apply to only new borrowers for now. The RBI further expects the banks to accelerate the transmission of monetary policy rates. 

Both the rates i.e MCLR and repo rate-linked rates existing simultaneously in the market may emerge a dual-rate structure, where the new borrowers can avail loans at much cheaper rates than existing borrowers. As time will pass, the Central Bank is expected to pass on the benefits to the existing borrowers as well. 

The new move will make the process more transparent since the borrowers will know the fixed interest rate and the spread decide by the lending bank. It will be much easier for borrowers to compare loans from different banks after the implementation of external benchmarking.