RBI asks Banks to link external benchmark for all floating rate loans from October 1, 2019

RBI has issued a circular, making it mandatory for banks to link all new floating rate retail loans like personal loan, housing loan, auto loans and floating rate loans to MSMEs to an external benchmark effective October 1, 2019. The circular dated September 4, 2019, permitted the banks to choose one of the several benchmarks like Repo, 3-month or 6-month Treasury bill yield, or any other benchmark published by the Financial Benchmarks India Private Ltd (FBIL) to link their lending rates. The Apex Bank further added that “In order to ensure transparency, standardisation, and ease of understanding of loan products by borrowers, a bank must adopt a uniform external benchmark within a loan category”. It means, the adoption of multiple benchmarks by the same bank is not allowed within a loan category.
Banks were required to reset the interest rate under external benchmark at least once in three months. However, regulator permitted the individual banks to choose spread over the benchmark rate at their discretion, subject to the condition that the credit risk premium may undergo change only when borrower’s credit assessment undergoes a substantial change, as agreed upon in the loan contract. Further, other components of spread including operating cost could be altered once in three years. The existing loans and credit limits linked to the MCLR/Base Rate/BPLR shall continue till repayment or renewal, as the case may be.
The RBI communication said that due to various reasons, the transmission of policy rate changes to the lending rate of banks under the current MCLR framework has not been satisfactory. In the ensuing financial year RBI has so far reduced the repo rate by 110 basis points, but the banks have reportedly passed on only up to 40 bps to borrowers. Further, industry and retail borrowers have been complaining to RBI that banks do not pass on the entire RBI’s policy rate (repo rate) reduction to them. Hence the above move of linking external benchmark aimed at ensuring faster transmission of policy rate cuts to borrowers.