Mumbai: The Reserve Bank of India (RBI) has asked the Indian Banks’ Association (IBA), the representative body of commercial banks, to look at new external benchmarks for floating rate loans. This, in a sense, acknowledges the banking sector’s contention that the central bank’s prescribed menu of benchmarks will create volatility in lending rates, leading to frequent changes in equated monthly instalments (EMIs).
In a bid to improve monetary transmission, an internal RBI group had proposed that all new floating rate loans should be linked to one of four external benchmarks: the RBI’s repo rate, treasury bill rates (91 days and 182 days), and corporate deposit rates.
The guidelines were supposed to be issued by the central bank by end-December 2018, for implementation by April 2019.
According to the RBI’s money market data, during the six-month period between 28 March and 28 September 2018, a repo rate increase of 50 basis points (bps) had resulted in the banking industry’s lending rate—calculated through the average marginal cost of funds-based lending rate (MCLR) of all commercial banks—going up by only 33 bps. At the same time, the 182-day T-bill yield had increased by 1.1 percentage points, while the 91-day T-bill went up by 90 bps.
One basis point is one hundredth of a percentage point.
Similarly, a 25 bps reduction in repo rate between 30 June and 31 December 2017 had led to a 23 bps cut in MCLR, while the 91-day T-bill moved by just 9 bps and the 182-day T-bill remained unchanged.
The T-bill yields are subject to fluctuating market conditions and react to changes in liquidity conditions, rate predictions, inflationary expectations and even fiscal news at the federal level.
“While the governor said that the issue of external benchmark pricing of loans is under review, we believe that the implementation will be pushed as RBI has still not come out with guidelines," said two bankers aware of the matter, requesting anonymity.
A survey of bankers, conducted jointly by the Federation of Indian Chambers of Commerce and Industry (Ficci) and IBA, showed that spreads kept by banks could be higher to protect themselves in case of high volatility of the benchmarks.
“Higher spread over the external benchmark could raise the overall interest rate for retail borrowers," said the survey.
The survey first mapped the banking sector’s average MCLR with the prevailing repo rate and the yields of the two T-bills between 4 January, 2016 and 31 December 2018.
Readjusting for the premium emerging between the MCLR and other rates, to make the study more comparable, the survey found that both the 91-day and 182-day T-bills were highly volatile. Referring to the risk in using external benchmarks, lack of depth in T-bill and certificate of deposits markets can make such benchmarks susceptible to manipulation. On the other hand, repo rate is an overnight rate and banks have limited access to funds at repo rate.
“T-bill may, at times, reflect fiscal risks, which will automatically get transmitted to the credit market when used as a benchmark. Repo rate lacks a term structure and banks have limited access to funds at repo rate," said the survey.
While banks want to continue with the MCLR regime, the RBI said that transmission under MCLR has remained muted as banks adjust it in an arbitrary manner.
“While some discretion remained with banks, the MCLR has continued to suffer from the same flaw in that transmission to the existing borrowers has remained muted as banks adjust, in many cases in an arbitrary manner, the MCLR and/or spread over MCLR, which has kept overall lending rates high in spite of the monetary policy being accommodative since January 2015," the RBI said in a 9 February 2018 report.
Monetary transmission in India has remained famously sticky with the RBI’s rate action taking a long time to feed into the banking sector’s lending and deposit rates. It is known that lending rates adjust upwards fast in response to monetary tightening, but are slow to come down when monetary policy is loosened or benchmark rates are cut. The opposite holds true for deposit rates: they are quick to come down when policy rates are cut, but sluggish to move up when the RBI increases the benchmark rates.