RBI aims to bring more transparency to your lending rates

Your lending rates will soon be priced in a much more transparent manner as the Reserve Bank of India aims to link the rates to an external benchmark.

After the monetary policy announcement on Wednesday, the RBI said that an internal committee report on lending rates has suggested that pricing of lending rates should be switched to an external benchmark in a time-bound manner.

An internal Study Group (Chairman: Janak Raj) was constituted by the central bank to study various aspects of the marginal cost of funds based lending rate (MCLR) system. The move is aimed to improve transmission of policy rates.

The Study Group, which submitted its report on September 25, 2017, observed that internal benchmarks such as the base rate/MCLR have not delivered effective transmission of monetary policy, RBI said.

Since April 2016, MCLR was implemented to decide interest rates on new loans but has not delivered the effective transmission of monetary policy.

“The overall experience with the transmission of monetary policy since the switchover to the MCLR regime from the base rate has not been fully satisfactory,” RBI has said in its monetary policy report.

Overall, the transmission of policy rate cuts of 200 bps or basis points (2 percentage points) since January 2015 has led the median base rate of banks to decline by only 75 bps, while MCLR rates have been reduced to 110 bps.

“Arbitrariness in calculating the base rate/MCLR and spreads charged over them has undermined the integrity of the interest rate setting process. The base rate/MCLR regime is also not in sync with global practices on pricing of bank loans,” RBI said.

The policy report also said, "Competition from small savings on which interest rates have generally been higher than term deposit rates, and which are not adjusted as per the announced formula by the government has also constrained transmission."

Viral Acharya, RBI's Deputy Governor, in a post policy interaction told reporters that the move to link rate to external benchmark is in line with international market and it will give a fair bit of transparency for borrowers. The report has said that three possible external benchmark that lending could be tied to and the report suggest quarterly reset so that transmission happens soon."

The report of the Study Group will be released on the Reserve Bank’s website today seeking comments from members of public and stakeholders. The Reserve Bank of India will take a final view on the recommendations of the Study Group after taking into account the feedback received until October 25, 2017.