Rate cuts for new home loans to be passed on automatically

RBI's external benchmark for loans Be ready for frequent changes in lending rates

RBI's external benchmark for loans Be ready for frequent changes in lending rates

"The RBI, therefore, has made 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 central bank said in a filing.

The RBI said banks were not satisfactorily transferring the cuts in policy rates.

"Based on the consultations with stakeholders, it has now been chose to link all new floating rate personal or retail loans (housing, auto, etc.) and floating rate loans to Micro and Small Enterprises extended by banks with effect from October 01, 2019 to external benchmarks", the RBI said in a statement. The interest rate under the external benchmark shall be reset at least once in three months.

When banks decide the rate they will charge for giving out loans, they set a benchmark below which they will not lend, and that incorporates the cost that the bank has to incur to give out the loan.

According to RBI, banks are free to choose one of the several benchmarks. Banks had argued that the MCLR formula is calculated based on cost of funds and these come down only gradually after a repo rate cut. For borrowers, this will mean faster transmission during both rise and fall of interest rates.

The RBI directive comes at a time when, despite four cuts in key policy rates totalling 110 basis points in 2019, banks have been slow to follow suit.

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However, a bank will have to adopt a uniform external benchmark within a category, meaning that the adoption of multiple benchmarks is not allowed within a category.

The RBI had in December a year ago as part of the fifth bi-monthly monetary policy of 2018-19 announced that all new floating rate personal or retail loans and floating rate loans to micro and small enterprises from April 1, 2019 would be linked to external benchmarks.

As for existing borrowers with floating rates, RBI has clarified that provided they are eligible to prepay a floating rate loan without pre-payment charges, these borrowers will be eligible to switch over to the external benchmark regime without any charges or fees, at mutually agreeable terms. These lenders include IDBI Bank, Bank of India, Union Bank of India, Central Bank of India, United Bank of India and Allahabad Bank, among others. Others who do not have the prepayment facility can move to external benchmark on terms acceptable to the bank and the borrower. The rule was supposed to apply to all new retail loans and small business loans with floating rates from that date.

The way banks set interest rates is critical for the smooth transmission of policy rates. Last year, though, was the first time that banks were asked to price their loans against an external benchmark.

VG Kannan, Chief Executive of the Indian Banks' Association, said customers will benefit from the move.

The RBI had first raised the issue of linking external benchmark to lending rates in its statement on developmental and regulatory policies on December 5, 2018. 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. Ghosh said close to 35% of bank liabilities are in the form of savings bank deposits and carry fixed interest rates.

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