Related Topics: Economy & Banking
- RBI has issued a circular making it mandatory for banks to link all new floating rate personal or retail loans and floating rate loans to MSMEs to an external benchmark effective October 1, 2019.
- The discussion was kicked off in August 2017, when RBI constituted an Internal Study Group (ISG) to examine the efficacy of the MCLR system, which reported that the system did not allow for effective transmission of rate cuts to customers.
- Even before RBI had made it mandatory, several banks, including State Bank of India, Bank of Baroda and Oriental Bank of Commerce had launched repo-linked lending rate products.
Why making External benchmark mandatory?
- By pegging the rate to an external benchmark, RBI is hoping for a faster transmission of rate cuts than has happened so far under the MCLR system.
- Banks have been reluctant to cut interest rates despite the RBI lowering the repo rate by 110 basis points (bps) between February 2019 and August 2019.
- At present, interest rates on loans are linked to a bank’s marginal cost of fund-based interest rate (MCLR).
- Existing loans and credit limits linked to the MCLR, base rate or BPLR, would continue till repayment or renewal.
- Banks can choose from one of the four external benchmarks — repo rate, three-month treasury bill yield, six-month treasury bill yield or any other benchmark interest rate published by Financial Benchmarks India Private Ltd (FBIL).
- Adoption of multiple benchmarks by the same bank is not allowed within a loan category.
- While banks are free to decide on the spread over the external benchmark, credit risk premium can change only when borrower’s credit assessment undergoes a substantial change.
- The interest rate under external benchmark shall be reset at least once in three months.
Transition to External Benchmark from MCLR
- Existing borrowers who have the option of pre-paying without incurring pre-payment charges will be eligible to shift to the benchmark-linked rate without any additional charges, except reasonable administrative and legal costs.
- For other borrowers, the option to move to an external benchmark will be available on the basis of their agreement with the bank.
About Financial Benchmarks India Private Ltd (FBIL)
- FBIL is jointly owned by the Fixed Income Money Market and Derivatives Association of India (FIMMDA), Foreign Exchange Dealers’ Association of India (FEDAI) and the Indian Banks’ Association (IBA).
- It was incorporated in December 2014 under the Companies Act 2013.
- It was recognised by Reserve bank of India as an Independent Benchmark administrator in 2015.
- Its aim is to develop and administer benchmarks relating to money market, government securities and foreign exchange in India.
- It also will make policies for possible cessation of any benchmark and to follow steps for ensuring orderly transition to the new benchmarks.
[Source: The Hindu, Livemint]