- All retail loans from April 1 to be linked to an external benchmark
- Policy rate transmission would be more effective
- Banks lose a tool for margin management
- NBFCs worse off as borrowers may gravitate towards banks and they lose pricing power
One of the key developments from the credit policy is the new guideline of benchmarking retail loans to an external benchmark.
For the central bank, this move partially addresses the issue of inadequate transmission. Simply put, when system rates went up or down the changes were not immediately reflected in the borrowing cost, thereby rendering the policy action less effective. Since retail loans are growing at a fast clip, making the move mandatory for retail and MSME addresses this issue to a large extent.
But how does this impact banks and NBFCs?
Following the report of the Janak Raj committee, RBI had been toying with the idea of replacing existing internal benchmarks like Prime Lending Rate (PLR), Benchmark Prime Lending Rate (BPLR), Base rate and Marginal Cost of Funds based Lending Rate (MCLR).
From April 1, 2019, all new floating rate personal or retail loans (housing, auto, etc.) and floating rate loans to Micro and Small Enterprises extended by banks shall be benchmarked to one of the following: -
- Reserve Bank of India policy repo rate
- Government of India 91 days Treasury Bill yield produced by the Financial Benchmarks India Private Ltd (FBIL)
- Government of India 182 days Treasury Bill yield produced by the FBIL, or
- Any other benchmark market interest rate produced by the FBIL
Transparency for borrowers
Retail-focused banks like HDFC Bank, Kotak Bank, IndusInd Bank or even the likes of ICICI Bank or Axis Bank with a growing share of retail assets as well as PSU banks that are increasingly eyeing retail assets, will from now on have to introduce an element of transparency in their lending yield.
The yield on retail advances will typically be = the external benchmark (one of the four at the discretion of the bank) + Spread over the benchmark.
The “spread over the benchmark” will be contingent on the risk assessment of the borrower.
The change from the customer perspective that is worth noting is that the spread over the benchmark rate should remain unchanged through the life of the loan unless the borrower’s credit rating undergoes a substantial change.
Less flexibility to manage interest margin
Previously banks generally were quick to undertake upward revision in lending rates when policy rates or market rates would harden but would be slow in passing on the reduction in rates. This was an important lever for margin management. That flexibility will now no longer be available to them. Having said that banks with superior liability franchise (higher low-cost deposits) should continue to report stable margins.
In addition, banks would be required to adopt a uniform external benchmark within a loan category; in other words, the adoption of multiple benchmarks by the same bank is not allowed within a loan category. Banks have been given the freedom to offer such external benchmark linked loans to other types of borrowers as well.
How does it impact NBFCs?
NBFCs (non-banking finance companies) have been fiercely competing in the retail market with banks. With banks introducing greater transparency in lending rates, it is likely that borrowers would incrementally prefer banks and to that extent, the competitive landscape turns adverse for NBFCs.
Previously, in a falling interest rate cycle, NBFCs used to benefit significantly as their wholesale liabilities used to get repriced down quickly while their asset yields were sticky. In the new regime, with banks being forced to pass on the reduced funding costs, NBFCs will also have to follow, which could, in turn, impact their margin.
In sum, while the move unequivocally benefits consumers thanks to the swift transmission and greater transparency, it takes away one key margin lever for banks and negatively impacts NBFCs from the margin as well as competition perspective.