Rates on loans to retail, small borrowers to be linked to external benchmark
Lowering the cost of funds for consumers and businesses is crucial for supporting economic growth
The Reserve Bank of India on Wednesday directed banks to link interest rates on loans to retail and small business borrowers to an external benchmark beginning 1 October to aid effective downward transmission of the central bank’s policy rate cuts.
However, banks can link loans to other segments of borrowers as well, RBI said. For borrowers, this will mean faster transmission during both rise and fall of interest rates.
Lowering the cost of funds for consumers and businesses is crucial for supporting economic growth since GDP expansion has slowed to the slowest pace in six years at 5% in the June quarter. Consumers and small businesses may expect their interest rate costs to fall in cases where banks haven’t already fully passed on RBI’s policy rate cuts.
Banks have been given the option to choose the external benchmarks, which include policy repo rate decided by the monetary policy committee (MPC). The other two benchmarks include Government of India’s 3-month and 6-month treasury bill yields published by the Financial Benchmarks India Private Ltd (FBIL). The banks can also use any other benchmark market interest rate published by the FBIL.
However, a bank will not be allowed to adopt multiple benchmarks within a single loan category. This limitation has been introduced to maintain transparency. Morevoer, banks are free to decide the spread under external benchmark, but the repo-linked interest rates have to be reset at least once in three months, RBI said in its statement.
WHAT IS THE REPO RATE:
The government has been pushing banks to link their loan interest rates to external benchmarks to ensure smoother transmission of changes in repo rates. The MPC has reduced the repo rate by 2.6 per cent since 2014, but the banks have reduced their lending rates by as low as 1.1 per cent during this period, keeping the benefits of the rate cuts from their customers.