During the consultations with RBI, several banks opposed the decision of linking lending rates to an external benchmark saying their cost of funds was not linked to those external benchmarks
In the first Bi-monthly monetary policy of FY20, Reserve Bank of India (RBI) postponed external rate benchmarking for floating rate loans till further consultations with stakeholders.
After the December 2018 monetary policy meet, the RBI had asked banks to link all floating rate retail loan products to external benchmarks starting April 2019.
As per its December statement, RBI had stated that they should benchmark the rates to either the RBI policy repo rate or Government of India 91-days or 182-days Treasury bill yield produced by the Financial Benchmarks India Private Ltd (FBIL) or any other external benchmark market interest rates produced by the FBIL.
Challenges for banks
RBI received issues from the banks while discussion on adapting to the external benchmark. Harsh Roongta, a Mumbai based registered investment advisor explained, “Major challenge is the management of interest rate risk by banks from fixed interest rate linked liabilities (fixed deposits, interest on savings account) against floating interest rate linked assets (loans). So, there is an inconsistency that banks want to resolve with the Central bank.”
During the consultations with RBI, several banks opposed the decision of linking lending rates to an external benchmark saying their cost of funds was not linked to those external benchmarks. They argued that lending rates should depend on the cost of funds, said a retail banker, requesting anonymity. Due to these issues, banks would need some time to prepare after the final norms are rolled out by the Central bank until further notice.
The path so far
In its December 2018 statement, RBI said banks were not quick enough to pass on the benefits of falling interest rates to borrowers. In April 2016, the regulator brought in the marginal cost of lending rate (MCLR) based products.
Now, with the linking of loan rates to external benchmarks, RBI felt that there would be a quicker transmission in key policy rates to borrowers. The logic here is that if interest rates fall, loan rates and their equated monthly instalments must also fall. Similarly, if the rates go up, customers will pay a higher amount towards EMI. Since, April 2016, all new loans are linked to the marginal cost of funds based lending rate (MCLR).
In order to make the cost of funds responsive to an external benchmark, State Bank of India (SBI) in March 2019 had announced that the bank had linked its savings bank rate with repo rate, with effect from May 1. Further, all cash credit accounts and overdrafts above Rs 1 lakh would be priced at 2.25 percent over the repo rate.
While the RBI guidance was to pass on the benefit of falling interest rates to borrowers by linking lending rate to an external benchmark, SBI also linked its savings bank rates (over a limit of Rs 1 lakh) to the external benchmark.
To justify the decision by SBI PK Gupta, Managing Director, SBI had told Moneycontrol at the time: “If policy transmission has to happen as per RBI regulatory, then both sides of the balance sheets have to be linked to policy rates by the banks. So, the best way to do policy transmission is to link savings bank rate to the policy rate. This gives us the flexibility to do policy transmission on the asset side as well.”Follow @thanawala_hiralYou can now invest in mutual funds with moneycontrol. Download moneycontrol transact app. A dedicated app to explore, research and buy mutual funds.