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Opinion | Why Indian banks need a push and not a nudge

Each time a new benchmark was introduced, RBI expected banks to pass on the cuts but it failed

Indian home loans float only in one direction—up. Successive Reserve Bank of India (RBI) governors have tried to use a mix of benchmarks, moral-suation and nudges to get the banks to be fair to a set of borrowers who now account for a large part of the banks’ loan books, but loan rates have remained sticky at higher levels. As borrowers, we know the pain of having a loan that gets very quickly revised upwards when the policy rate rises, but stays high when the policy rates fall. Banks have managed to manage all benchmarks tried out every few years by RBI. The BPLR, base rate and the MCLR are the various benchmarks (read about these here) tried out over the past. Each time a new benchmark was introduced, RBI expected banks to pass on the rate cuts, but each time it failed.

It has taken the finance minister of an aspiring $5 trillion economy to announce, as a part of a pick-me-up package for the economy, that all banks will now have to use either a third-party benchmark or a repo rate-linked benchmark to price their loans. It takes an FM to fix a fair benchmark in Indian banking. A benchmark is a very important number in the financial sector because the entire industry deals in things that are invisible. When we buy a car, we can see it, experience its speed, mileage and comfort. When we buy a home loan or a mutual fund, the product is invisible; its performance has to be compared with something else for us to make meaning out of it. A benchmark is that number that provides that bar or threshold that helps us make sense of our products—to see if they are doing well or are fair. In a mutual fund, the benchmark must reflect the choice of stocks or bonds in a particular fund. A small-cap fund, for example, must have a benchmark that is made up of small-cap stocks. To compare a small-cap fund with the broad-market index will mis-represent the performance of the fund, both up and down. A benchmark for a floating home loan must be such that it moves up and down as the policy rate moves up and down. But banks have misused the freedom to fix their own benchmarks and have short-changed retail borrowers for decades. One brave bank that tried a MIBOR (or the Mumbai Interbank Offer Rate—a third-party benchmark not controlled by a single bank) linked loan in 2005 has not survived to tell the story of being fair to bank customers. You can read more about this here.

Is it fair to force banks to lend against a benchmark they cannot control? Isn’t this against the free-market principle and won’t banks face difficulties in managing their assets and liabilities? The answer to all of these is: no. It is not unfair. A better regulator would have solved this years ago rather than giving in to the banks threat of failure when faced with a consumer-friendly and bank fees-unfriendly proposal. The free market argument falls flat on its face on many counts and the biggest reason is that the regulator’s job is itself conflicted. What hat is RBI going to wear—the manager of public debt, the regulator of banks or the protector of systemic risk who ensures that banks don’t fail? RBI’s traditional focus on preventing bank failure has not allowed it to look at its role as a protector of customer interests. RBI would rate a “poor" on the report card under the head—protection of retail customers. It is yet to action its charter of consumer rights and to make banks accountable for third-party products sales, to name just two. So, no, it is not unfair to ask for a fair marketplace for a set of consumers whose voices are individually too weak to be heard in the ivory tower on Mint Street.

Though it is not the job of the finance minister to tinker with benchmarks or the finer details linked to markets, for us as consumers of products in an oligopolistic marketplace called banking, it is good news that loans may finally float down. But I won’t celebrate too soon—but would look carefully at the fine print when banks begin to offer the repo-linked loans to see where the catch is. Maybe RBI will have to fix a window within which banks have to get their loans to react to repo rate changes, or banks will reset the loan rates once in a year.

Monika Halan is consulting editor at Mint and writes on household finance, policy and regulation

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