BackInterest rate transmission improved after use of external benchmarks: RBI
RBI has mandated banks to link all new floating rate personal, and micro and small enterprises (MSEs) loans to an external benchmark
PremiumMUMBAI: The transmission of policy repo rate changes to deposit and lending rates in the banking system has improved since the introduction of external benchmark-based pricing of loans, said an article in Reserve Bank of India (RBI) July bulletin.
From October 2019, RBI has mandated banks to link all new floating rate personal, and micro and small enterprises (MSEs) loans to an external benchmark, like the policy repo rate or three-month or six-month treasury-bill rate or any other benchmark market interest rate published by Financial Benchmarks India Private Ltd (FBIL). Then, since April 2020, loans to medium enterprises have also been linked to an external benchmark.
Data collected from banks, RBI said, suggest that the share of outstanding loans linked to external benchmarks increased from as low as 2.4% during September 2019 to 28.5% during March 2021.
“In a country like India where the banking system constitutes a predominant segment of the financial system and plays a leading role in financial intermediation, efficient transmission to banks’ deposit and lending interest rates assumes significance," it said.
The article pointed out that in response to the cumulative reduction of policy repo rate by 250 basis points (bps) since February 2019, the one-year median marginal cost of funds-based lending rate (MCLR) of banks declined by 155 bps in the same period. Transmission to lending rates has improved considerably in the current easing phase up to May and more so since October 2019 when there has been a complete pass-through of repo rate cuts to the weighted average lending rate on new rupee loans, it said.
“The adoption of external benchmark-based pricing of loans strengthened market impulses for quicker adjustments in deposit rates. The weighted average domestic term deposit rate on outstanding rupee deposits has declined by 152 bps since October 2019 as compared to the decline of mere 7 bps during February-September 2019," the article said.
However, the transmission to deposit and lending rates has been uneven across bank groups. For public sector banks factors like greater dependence on retail term deposits and competition from alternative saving instruments like small savings, constrains them from lowering deposit rates in sync with the policy repo rate, it said. Its private sector peers have exhibited increased pass-through to lending and deposit rates compared during the external benchmark regime.
“A combination of surplus liquidity conditions amidst weak credit demand has enabled banks to lower their deposit rates and hence the lending rates," the article said.
Meanwhile, it added that the response of money and corporate bond markets to monetary policy changes has been highly elastic during the current easing cycle that began on 7 February 2019 and more so since March 2020 or in the aftermath of covid-19. Although the outbreak of covid-19 triggered bouts of volatility in financial markets, the article said that a slew of policy measures announced by the central bank ensured easy financing conditions and restored orderly functioning of markets.
“In the corporate bond market segment, yield on AAA rated five-year bond has softened cumulatively by 237 bps (up to June 30), in response to the policy repo rate cut of 250 bps effected through the easing cycle since February 2019," it said.
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