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MUMBAI : The Reserve Bank of India (RBI) on Thursday said there are early indications that transmission of interest rates in fresh floating rate loans has improved after external benchmarks were introduced in October.

In its Monetary Policy Report for April, the central bank said that between October 2019 and February 2020, the weighted average lending rate of banks in fresh loans have declined. Interest on housing loans fell by 34 basis points (bps), vehicle loans by 73bps, education loans by 21bps and loans for micro, small and medium enterprises (MSMEs) by 6bps.

Last year, RBI had directed banks to move all floating rate retail and small business loans to an external benchmark to quicken transmission of interest rates. Banks can now choose between the repo rate, the yield on three-month or six-month treasury bills, or any other benchmark rate published by the Financial Benchmarks India Pvt. Ltd (FBIL).

According to RBI, of the 62 banks from whom information was collected, 36 adopted the policy repo rate as the external benchmark. Six banks have linked their loans to various other benchmarks published by FBIL, such as certificate of deposit (CD) rate, overnight index swap (OIS) rate, Mumbai Interbank Outright Rate (MIBOR) and three-month T-Bill rate. Eleven other banks, RBI said, have linked different sectors to different benchmarks and nine foreign banks do not have any retail or small business loans, and therefore, does not come under the ambit of external benchmarks.

“The median spread in respect of fresh rupee loans linked to the policy repo rate was the highest for other personal loans. Among the bank-groups, the median spread charged by public sector banks for different categories of loans was lower than that charged by private sector banks," RBI said. The median spread is defined as the difference between the median weighted average lending rate and the repo rate.

“Since the October 2019 Monetary Policy Report, monetary policy transmission to banks’ term deposit and lending interest rates has improved."

Meanwhile, this effective transmission has also led to faster decline in deposit rates. RBI said that the pass-through of the policy rate cut to the weighted average domestic term deposit rate on outstanding deposits improved to 39bps during October 2019-February 2020 from a mere 7bps during the previous eight months (February-September 2019), resulting in an overall reduction of 46bps.

The weighted average lending rate on outstanding rupee loans has also declined by 18bps since October 2019 in contrast to a rise of 2bps during February-September 2019, RBI said.

According to the Monetary Policy Report, the improvement in transmission during the second half of FY20 to banks’ deposit and lending rates reflected the lagged impact of the previous rate cuts (110bps during February–September 2019) and the introduction of the external benchmark system.

RBI also said that administered interest rates on small saving schemes set by the government have implications on monetary transmission. These administered interest rates are linked to market yields on government securities (G-secs) with a lag and are fixed on a quarterly basis at a spread ranging from 0-100bps over and above G-sec yields of comparable maturities, it added.

On 31 March, the government sharply cut rates of interest on all small saving schemes (except saving deposits) in the range of 70-140bps for Q1 FY21. Following the revision, the central bank said, interest rates on small saving schemes for Q1 FY21 are broadly aligned with the prescribed formula-based administered interest rates on small savings, and augurs well for monetary transmission, going forward.

ABOUT THE AUTHOR

Shayan Ghosh

Shayan Ghosh is a national writer at Mint reporting on traditional banks and shadow banks. He has over a decade of experience in financial journalism. Based in Mint’s Mumbai bureau since 2018, he tracks interest rate movements and its impact on companies and the broader economy. His interests also include the distressed debt market, especially as India’s bankruptcy law attempts recoveries of billions worth of toxic assets.
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