Currently, banks price their loans based on their marginal cost of funds-based lending rate (MCLR)
In December, RBI said that banks must set their interest rates for new loans against an external benchmark beginning 1 April
The Reserve Bank of India (RBI) is considering asking banks to link loans to an external benchmark such as the repo rate to improve transmission of policy rates and foster economic growth, said central bank governor Shaktikanta Das.
“The time has now come to formalize the linking of the lending rates on new loans to external benchmarks like the repo rate. We are monitoring the developments in this regard and whatever steps are required in the coming weeks will be taken by RBI," Das said at a conclave organized by the Indian Banks’ Association and industry lobby group Ficci on Monday. Das did not say if formalization would mean the central bank will issue specific guidelines on this.
In December, RBI said that banks must set their interest rates for new loans against an external benchmark beginning 1 April. The rule was supposed to apply to all new retail loans and small business loans with floating rates from that date.
The proposal, however, was opposed by bankers who wrote to the regulator citing their concerns. In April, Das postponed the linking to external benchmarks and said RBI would discuss the proposal with the parties concerned before taking a decision on implementing it.
“We have kept the external benchmark (rules) in abeyance because we wanted to see how the market evolves. It is a positive trend that banks have responded but this process needs to be faster," he said.
Das said the transmission of policy rates at just 29 basis points (bps) this year compared to a combined repo rate cut of 75bps (excluding the 35bps cut in August) did not meet RBI’s expectations.
“It (transmission) should be and can be better," he said.
He added that since the last meeting of the monetary policy committee, several banks announced initiatives to link their new loans to the repo rate. “Our expectation is that they should move faster," said Das.
RBI is constantly in discussions with banks to accelerate transmission of monetary policy rates, said Das.
“The RBI will definitely play its role as the regulator to work with the banks to see the trends in the market and take steps that can formalize these linking of new loans to repo rate or other external benchmarks," he said.
The way banks set interest rates is critical for the smooth transmission of policy rates. To make this process transparent, RBI has over the years directed banks to price their loans against their benchmark prime lending rate (BPLR), base rate, and, finally, MCLR. Last year, though, was the first time that banks were asked to price their loans against an external benchmark. Das also highlighted the importance of strengthening banks’ corporate governance structures, including efficient functioning of boards and board subcommittees; robust system for monitoring of performance of managing directors/CEOs; and, an effective performance evaluation system to improve the financial and operating parameters.
“We have already sent our suggestions to the government for governance reforms in public sector banks," he said.
The governor ruled out asset quality review of non-bank lenders, along the lines of what was done for banks in the third and fourth quarters of the year ended March 2016. “At the moment, there is no proposal for an asset quality review of non-banking financial companies (NBFCs). The top 50 NBFCs and housing finance companies (HFCs) are being very closely monitored by us," he said. Including HFCs, the size of the NBFC sector constitutes about 25% of the combined balance sheet of scheduled commercial banks. The central bank, Das said, will take necessary measures to deal with the challenges in the sector.