RBI Orders Banks to Link Retail, MSMEs Loans to External Benchmarks

The Reserve Bank of India (RBI) has made it mandatory for banks to link loans to retail customers and micro, small and medium enterprises (MSMEs) to external interest rate benchmarks in a big push to make transmission of monetary policy more effective. Home and car loan rates, along with those for personal travel, are expected to fall, benefitting borrowers, reports The Economic Times.
The RBI also suggested a series of rates that lenders can choose from as the peg. The new pegs include the RBI’s repo rate, the three-month or six-month treasury yield published by Financial Benchmarks India Ltd (FBIL) or any other benchmark published by the latter, the RBI said. 
When the new framework goes into effect on October 1, banks will have to migrate from the Marginal Cost of Lending Rate (MCLR) regime. The RBI has left risk premium charges to be decided by the lenders, depending on the borrower’s credit profile. 
However, the central bank has also drawn up rules to prevent banks from gaming the system by tweaking risk premiums unless there’s a material change in the status of the borrower. The interest rate under the external benchmark shall be reset at least once in three months. 
The central bank has been struggling for more than a decade to improve the transmission of rate changes to ultimate borrowers. It tried prime lending rates and base rates before zeroing in on the MCLR, which is based on the cost structure of the bank in the latest quarter.
At a banking conference last month, Das said the transmission of policy rates at just 29 basis points (bps) this year, compared with a combined repo rate cut of 75 bps (excluding the 35bps cut in August), did not meet RBI’s expectations. 
While rates were roughly congruent with the movement of the repo rate, banks had the freedom to charge a premium based on the customer’s risk profile. A poor credit score could lead to a high premium over the benchmark and vice versa, which couldn’t be altered at will. 



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