Here is why RBI wants leading rates to be linked with external benchmark rates
, ET Bureau|
Updated: Oct 04, 2017, 07.33 PM IST
MUMBAI: 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 external benchmark rates arrived at by market trading rather than leaving it at the discretion of each bank which appear to be coming up with some formula that would defy the best rates for most customers.
"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 pricing of bank loans."
Banks and the RBI have been at loggerheads 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.
The report has suggested three possible benchmarks to which lending could be linked. 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.
"We think it's time to move to how it works in most other countries which is getting these rates tied to external benchmarks,'' said Acharya. ``It will create a fair bit of transparency for borrowers. They can just compare two loans and see which is at a lower spread. It leaves open which of these benchmarks should be used."
A Reserve Bank of India committee headed by Dr Janak Raj has suggested that interest rate on loans be pegged to external benchmark rates arrived at by market trading rather than leaving it at the discretion of each bank which appear to be coming up with some formula that would defy the best rates for most customers.
"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 pricing of bank loans."
Banks and the RBI have been at loggerheads 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.
The report has suggested three possible benchmarks to which lending could be linked. 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.
"We think it's time to move to how it works in most other countries which is getting these rates tied to external benchmarks,'' said Acharya. ``It will create a fair bit of transparency for borrowers. They can just compare two loans and see which is at a lower spread. It leaves open which of these benchmarks should be used."
