Loan borrowers rejoice! RBI recommends new benchmark for lending rates

The Reserve Bank of India (RBI) has suggested bringing in place an external benchmark rate to link lending rates for faster transmission of rate cuts to the borrowers by the banks. This is in line with recommendation made by a study group set up by the RBI to review the working of the Marginal Cost of Funds Based Lending Rate (MCLR) system. In April 2016, RBI came up with a new benchmark-MCLR for faster transmission of rate cuts. However, varying reset periods under the same and tweaking by banks led to considerable time lag in full transmission of the rate cut, thereby defeating its whole purpose.

The external benchmark may come into effect from 1 April, 2018. The study group has recommended three external benchmarks options: T-Bill rates, the CD rates and the Reserve Bank's policy repo rate. Of all, it finds the repo rate the best benchmark for effective transmission of rate cuts.

"The main challenge in using either T-bill rates or CD rates as the benchmark is that the current level of market depth in the T-Bill and CD markets can make such benchmarks potentially susceptible to manipulation. The Reserve Bank's policy repo rate has the primary advantage that it is robust, reliable, transparent and easy to understand. With the repo rate as the benchmark, the transmission of the repo rate changes to lending rates of banks will be quick, direct and strong," the report by the study group said.

The report expressed concern over considerable transmission lag in lowering the lending rate after reduction in MCLR "In the case of private sector banks, it took almost six months for the transmission from the lower MCLR to actual lending rates. However, in the case of public sector banks, the transmission was not complete even after six months," the report further added.

The group also batted for allowing seamless and cost-free migration to MCLR system by banks to its customers, in its report. It further recommended the reduction of reset period  from once in a year to once in a quarter on MCLR, and also raised the issue of spread over and above the benchmark rate.

"The decision on the spread over the external benchmark should be left to the commercial judgment of banks. However, the spread fixed at the time of sanction of loans to all borrowers, including corporates, should remain fixed all through the term of the loan, unless there is a clear credit event necessitating a change in the spread