MUMBAI: If you have a loan and it is on a floating rate, you will know that it is linked to a benchmark lending rate which can vary depending on the interest rate cycle.
In the December monetary policy meet, the Reserve Bank of India (RBI) had proposed that all banks should link floating rate loans to external benchmark rate from 1 April 2019, and do away with marginal cost of funds-based lending rate (MCLR) to provide transparency. The central bank had given three options—policy repo rate, 91 days treasury bill yield, 182 days treasury bill yield or any other benchmark market interest rate produced by the Financial Benchmarks India Pvt. Ltd.
Currently, all new loans are linked to MCLR since 1 April 2016. However, the proposal is under review and bankers say the implementation is challenging.
External benchmark rate still under review
Last week, during the latest monetary policy announcement, the RBI said the proposal to link loans to external benchmark is still under review.
“The discussion paper was placed in the public domain regarding external benchmark rate. We have got a lot of comments from the public as well as from banks. It is currently under examination," said RBI governor Shaktikanta Das, during the monetary policy announcement.
According to bankers, shifting to external benchmark rate will be a challenge considering banks in India depend on deposits to lend money and depositors look for fixed rates. “Any depositor wants a fixed rate of interest. In India, banks depend on public deposits. If you look at the banks’ liability side on balance sheets, almost 85-90% is deposits. And rest is capital reserves. If you are so dependent on public deposits and you remove savings account, which is a fixed rate of interest, from there, your
floating rate on liability side will be practically absent in bank balance sheets. On the asset side, if you move everything to market benchmark-linked pricing, then there will be huge asset-liability mismatch for the bank. Right now, it is linked to MCLR which is linked to deposit rates. When you have an external rate, banks have to be successful in raising floating rate deposits. If I am lending something on say a three-month treasury bill, I should be able to raise deposits linked to three-month treasury bills," said Ashutosh Khajuria, executive director and chief financial officer, Federal Bank Ltd.
The RBI governor had further said the apex bank is in talks with banks for monetary transmission. “Whenever there is a policy rate reduction, it is RBI’S expectation that monetary transmission takes place. But we have to keep in mind that the lending and fixing of the rate of interest is a function of the banks. We will be having an interaction
as I mentioned in the next fortnight or so. We will have meetings with CEOs and MDS of all banks and we will be discussing these issues, including the issue of monetary transmission and let’s see," Das said.
Though it is still wait and watch for the implementation of external benchmark rates, two things are likely to happen.
One, banks may look at opting for floating rate deposits to implement external-linked benchmark rate. So, instead of fixed deposit, you may have floating rate deposits.
Two, if the external benchmark rate is implemented, your interest rates will change faster than usual, making your loans rates more volatile.
Also, you will have a higher spread on your home loans than the existing one.
It is too early to say whether it will work or not.