New lending rate regime: Is RBI fixing what is not broken?
The Reserve Bank of India (RBI) is clearly a frustrated central bank when it comes to monetary policy transmission. After changing the way banks charge their borrowers twice and browbeating them countless times, the regulator is nowhere close to pushing lenders to swiftly transmit its policy rate measures.
A panel involving RBI’s staff would have us believe that despite introducing newer and more scientific ways to calculate the lending rate, banks are still charging interest rates based on arbitrarily arrived spreads.
RBI wants to change this yet again and bankers are predictably opposed to what the central bank’s panel has recommended.
The panel has made nine recommendations that range from the workable to myopic to naive.
It recommends that banks recalculate their base rates immediately and pass on the 200 basis points cumulative reduction in policy rates since January 2015 to the final lending rate charged to at least 30% of the borrowers still. A basis point is a one-hundredth of a percentage point.
This should be done given that base rates have hardly been cut, making a mockery of transmission. The report of the panel shows that weighted average lending rate on outstanding loans has fallen by 61 basis points since April 2016 while those on fresh rupee loans has fallen by a higher 95 basis points. April 2016 was when the new marginal cost of funds based lending rate (MCLR) was introduced. RBI adds that banks are reluctant to make customers aware of MCLR and convert base rate-linked loans to MCLR.
The simplest solution to this would have been a sunset clause for the base rate akin to what was prescribed for benchmark prime lending rate. RBI has neither done that nor given a reason for it.
Another recommendation is that loans sanctioned after April 2018 should be linked to an external benchmark prescribed by the central bank. The acceptable external benchmarks given by the panel are Treasury bills (T-bills) rates, certificates of deposit (CDs) and RBI’s policy rate. The main grouse of RBI seems to be that banks charge arbitrary spreads over MCLR making the final lending rate steep even in cases where a reduction in loan rates is warranted. But linking loans to a market-based rate hardly solves this. Instead, what it will do is make lending rates volatile.
Asking banks to link their loan rates to a market benchmark that has no direct linkages to their liability book is grossly unfair. T-bill yield is the funding cost of the government, not banks. A major risk is that T-bills and CDs yields can be easily manipulated given that the market is shallow. CDs hardly account for cost of funds of lenders. RBI’s repo rate is an overnight rate and calculating the risk and tenor premium would bring back the issue of spreads full circle.
For all its shortcomings, transmission through MCLR has been reasonable and better than that of the previous regimes. In making yet another change in lending rates, the central bank is fixing what is not broken. The larger question is whether RBI should be prescribing how commercial banks decide their lending rates.