RBI wants leading rates to be linked with external benchmark rates

RBI wants leading rates to be linked with external benchmark rates

Those who avail of home loans and personal loans could soon be on par with the big corporates when it comes to how banks calculate interest charges on borrowers. Interest rates on loans across the board would soon be benchmarked to external market rates as the banking regulator aims to put an end to opacity of loan pricing by banks.

A Reserve Bank of India committee headed by Dr Janak Raj has suggested that interest rate on loans be pegged to anyone of the three benchmark rates such as T-bill, certificate of deposit rate or the RBI's repo rate rather than leaving it to the discretion of each bank. It also suggested a ban on banks charging a conversion fee whenever the bank resets the rate of interest.

"Arbitrariness in calculating the base rate and MCLR and spreads charged over them has undermined the integrity of the interest rate setting process,'' RBI said in a statement.such as T-bill, certificate of deposit rate or the RBI's repo rate rather than leaving it to the discretion of each bank. It also suggested a ban on banks charging a conversion fee whenever the bank resets the rate of interest.

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

Banks and the RBI have been at logger heads for over a decade with the regulator publicly stating that banks move interest rate in such a way that it benefits them. Banks have been quick to raise interest rates when the RBI raised policy rates, but were slow to cut when RBI did so.

"We think that the internal benchmarks like the base rate or the MCLR, based on data, seem to give banks a very high amount of discretion lot of factors that are flexible for them to ensure that lending rates can be kept high even when monetary policy rates are going down an accommodative path," deputy governor Viral Acharya told reporters.Data from the RBI shows that, between December 2014 and October 2016, a month before the demonetisation of Rs. 500 and  Rs. 1,000 notes, banks' Base Rate on an average reduced 0.61 percent when the policy rate was lowered by 1.75 percentage point.

Banks were slow to pass on the reduction in their MCLRs in January 2017 to their actual lending rates,'' said the report. ``Of the 12 banks whose spreads widened, six banks took up to six months to pass on the benefit of lower MCLRs to their lending rates; the remaining six banks passed on the benefit of their lower MCLRs, but only partially even after six months. This is intriguing as changes in MCLRs are expected to be passed on to at least fresh borrowers immediately.''

The report also suggested that interest rates resets which are now set at annual frequency creating potentially a one year lag in transmission that these be changed on floating rate loans to quarterly resets.This is done to ensure that the transmission will be much faster. As on now, banks have adopted marginal cost of lending rate (MCLR) formula where rates are linked to cost of their funds and are reset in different internals such as one month, six months to one year

`The Study Group is of the view that the decision on the spread over the external benchmark should be left to the commercial judgment of banks,'' the report said. ``However, the spread fixed at the time of sanction of loans to all borrowers, including corporates, should remain fixed all through the term of the loan, unless there is a clear credit event necessitating a change in the spread.''

The Economic Times, New Delhi, 18th November 2017