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Business News/ Industry / RBI suggests move to more transparent pricing of loans
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RBI suggests move to more transparent pricing of loans

Banks should formulate base rate after taking into account marginal cost of funds, says RBI panel headed by Anand Sinha

The RBI committee to review the pricing of credit had been set up in October 2011 in response to calls for greater transparency in the manner in which banks set loan rates. Photo: Pradeep Gaur/MintPremium
The RBI committee to review the pricing of credit had been set up in October 2011 in response to calls for greater transparency in the manner in which banks set loan rates. Photo: Pradeep Gaur/Mint

Mumbai: Banks should be barred from widening the spread between their minimum lending rate and the interest rate at which they have loaned money to a customer, unless the borrower’s risk profile deteriorates, a Reserve Bank of India (RBI) panel said in a draft report.

The Indian Banks’ Association (IBA) should also develop a benchmark for floating rates and publish it periodically, the panel said. Lenders should consult this benchmark at the time of lending, the panel suggested. In addition, banks should formulate their base rates after taking into account their marginal cost of funds, said the report prepared by a working group headed by RBI’s former deputy governor Anand Sinha.

If the suggestions are accepted, it may “result in more transparency in pricing, reduced customer complaints, better transmission of changes in the policy rate and improved asset liability management at banks", according to the report.

“Banks’ ability to transmit monetary policy is rigid, as was seen in 2012-13 when they passed on only about a third of the policy rate reduction to customers," said Ananda Bhoumik, senior director at India Ratings and Research, a Fitch Group company. “India Ratings’ research shows that this rigidity is structural, brought about by wide asset-liability mismatches due to funding longer tenure loans with short term deposits. The resulting refinancing risk elevates the marginal cost of funds of vulnerable banks. Using marginal cost of funds to measure base rate will help in improving transmission, but can render these banks uncompetitive and increase earnings volatility."

Banks now formulate their base rate on a weighted-average cost of funds that clubs good and bad customers, as well as new and existing customers.

An official of industry lobby group Indian Banks’ Association (IBA) said the panel’s suggestion to create a benchmark for floating interest rate loans is aimed at creating a standard industry reference point for loans.

“Base rate is an internal decision by banks. However, the idea for IBA reference rate is to create a benchmark for the customer to see," said the official who did not wish to be named because he is not authorized to speak to reporters.

Banks that depend on fixed rate deposit products do not have the flexibility to transmit any policy rate change by RBI as their cost of funds does not decrease immediately.

In addition, the liquidity conditions in the market also affect the behaviour of the base rate as the interbank call rate goes up at times of tight liquidity. Since the call rates are mostly above the policy rate, “any easing of the policy rate may not impact the base rate in such a scenario", the report said.

These problems can be solved to a large extent if banks move to an incremental cost of deposit instead of weighted-average cost of deposits, analysts said.

To ensure greater transparency in credit disbursement, the committee has recommended that in a floating rate loan, the interest rates should be reset based on the loan contract and not when a bank changes its base rate.

“The floating rate loan covenant may have interest rate reset periodicity and the resets may be done on those dates only, irrespective of changes made to the base rate within the reset period," said the draft report.

For retail loans, the central bank panel recommended that customers should be able to pick a ‘with exit’ or a ’sans exit’ option at the time of entering into a loan contract. “The exit option can be priced differentially but reasonably," said the draft report. The exit option should be easily exercised by a customer with a minimum notice period and without impediments.

According to an analyst with a local brokerage, this may mean that if a customer signs a ‘sans exit’ clause, his or her ability to switch his loan to some other bank will be restricted. But if she signs a ‘with exit’ clause, she could be charged a premium for the flexibility of a future switch. The analyst did not wish to be named given the lack on clarity on the issue.

The Anand Sinha committee to review the pricing of credit had been set up in October 2011 in response to calls for greater transparency in the manner in which banks set loan rates.

“Despite the policy efforts to usher in transparency and fairness to the credit pricing framework, there have been certain concerns from the customer service perspective," the panel said. “These mainly relate to the downward stickiness of the interest rates, discriminatory treatment of old borrowers vis-à-vis new borrowers, and arbitrary changes in spreads, etc."

The central bank has sought comments and feedback on the recommendations of the draft report till 16 May.

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Published: 10 Apr 2014, 07:02 PM IST
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