Noting arbitrariness in setting loan rates, RBI panel suggests external benchmarking | business-news | Hindustan Times
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Noting arbitrariness in setting loan rates, RBI panel suggests external benchmarking

The RBI will take a final view on the recommendations of the panel after taking into account the public feedback received until 25 October

business Updated: Oct 04, 2017 22:40 IST
Alekh Archana
A police officer stands guard in front of the Reserve Bank of India (RBI) head office in Mumbai, August 9, 2016.
A police officer stands guard in front of the Reserve Bank of India (RBI) head office in Mumbai, August 9, 2016. (Reuters)

A committee set up by the Reserve Bank of India (RBI) on Wednesday recommended linking bank lending rates to a market benchmark in a bid to hasten monetary policy transmission as well improve transparency in rate setting by lenders.

The committee headed by Janak Raj, principal adviser, monetary policy department, recommended that all floating rate loans advanced from April could be referenced to one of three external benchmarks. The panel has suggested a risk-free curve involving rates on treasury bills, or certificate of deposits rates or the central bank’s policy repo rate.

The RBI will take a final view on the recommendations of the panel after taking into account the public feedback received until 25 October.

The panel pulled up banks for “arbitrariness” in calculating the base rate and marginal cost of funds-linked lending rates, two existing benchmarks to which retail lending rates such as car loan and home loan rates are fixed. The spreads charged over these internal benchmarks “has undermined the integrity of the interest rate setting process,” it said.

The panel has recommended that lending rates should be reset once every quarter from the current practise of once a year.

It also suggested that banks migrate all existing borrowers who are now charged under benchmark prime lending rates, base rates or the marginal cost of funds based lending rate (MCLR) to the external benchmarked rate without any conversion fee or other charges within one year of its introduction, i.e March 2019.

Introduced in April 2016, the MCLR system replaced the base rate regime. According to the panel, in the absence of any sunset clause on the base rate, banks were slow in migrating their existing customers to the MCLR regime. It suggested that all existing borrowers under any other system be moved to MCLR.

Since April 2016 , the one-year MCLR has come down by 95 basis points (bps) whereas the repo rate is down by 75 bps, but MCLR has been mostly used for fresh loans. In some cases, banks’ spreads spread over the MCLR in the form of tenor and risk premium was different for customers in the same risk category, the panel noted.

The study noted that large reduction in MCLR was partly offset by some banks with a simultaneous increase in the spread in the form of business strategy premium, ostensibly to reduce the pass-through to lending rates.

The group has suggested that decision on the spread over the external benchmark should be left to the commercial judgment of banks. However, the spread fixed at the time of sanction must remain throughout the life of the loan, unless there is a clear credit event necessitating a change in the spread.

At a post-policy conference on Wednesday, Viral Acharya, deputy governor of RBI, said internal benchmarks such as the MCLR seem to give banks a high amount of discretion and help them keep lending rates high even if RBI cuts rates.

“In order to address this, we think it is time to move to how it works in most other countries, which is to have these rates tight to (an) external benchmark. It will create a fair bit of transparency for borrowers,” he said.

The committee also said that banks may be allowed to offer bulk deposits at floating rates linked directly to one of the three external benchmarks selected by the Reserve Bank.