EXTERNAL BENCHMARK FOR LOAN PRICING

Feb. 26, 2019

From April 1, most commercial banks in India are likely to select RBI’s repo rate as the external benchmark to decide their lending rates as the repo rate is the most stable one as compared to the other options.

About:

Present status: The marginal cost of fund based lending rate (MCLR) is currently the benchmark for all loan rates. Banks typically add a spread to the MCLR while pricing loans for homes and automobiles.
Decision by RBI:
- The Reserve Bank of India (RBI) had asked the banks to move to an external benchmark for loan pricing from April 1.
- For the new benchmark, the spread over the benchmark rate — to be decided by banks at the inception of the loan — should remain unchanged through the life of the loan, unless the borrower’s credit assessment undergoes a substantial change and as agreed upon in the loan contract.
- RBI is expected to issue the final guidelines on the matter in March.
Options given: Banks had four options from which to choose the external benchmark -
- the repo rate,
- the 91-day treasury bill,
- the 182-day T-bill or
- any other benchmark interest rate produced by the Financial Benchmarks India Private Ltd (FBIL).
Significance: The move is expected to improve monetary transmission as lenders had, in the past, been found reluctant to reduce lending rate.