MUMBAI: The Reserve Bank of India (RBI) on Wednesday refused to tinker with the repo rate, but interest rates for borrowers could come down as the central bank is planning to link rates to an external benchmark. Such a move, a first for RBI, allows faster monetary policy transmission as the impact via the prevailing base rate and Marginal Cost of Fund-based Lending Rate (MCLR) was slower than desired.
For instance, RBI cut repo by 200 basis points (bps) since January 2015. While rates for fresh loans were cut by 193 bps, for outstanding loans the transmission is muted at 125 bps, suggesting scope for banks to reduce rates further.
An internal RBI group suggested switching over to an external benchmark in a time-bound manner so that better rates are available to borrowers. “The RBI study group has observed that internal benchmarks such as the base rate/MCLR have not delivered effective transmission of the monetary policy,” RBI said. The study group submitted its report on September 25.
MCLR was introduced on April 1, 2016 as the then prevailing base rate could not deliver faster transmission. Prior to the MCLR, banks followed an even rigid base rate system, which came into force on July 2, 2010 replacing the banks’ prime lending rate. “Arbitrariness in calculating the base rate/MCLR and spreads charged over them has undermined the integrity of the interest rate setting process,” the study group has observed.
According to RBI Deputy Governor Viral Acharya, the group has proposed three possible external benchmarks. “We think the internal benchmarks such as the base rate and MCLR, based on data, seem to give banks very high amount of discretion, lots of factors that are flexible to them to ensure that the lending rate can be kept high even if monetary policy is going down and accommodative,” he said adding that the idea was to create transparency for borrowers to compare loans.
The report also suggests that “the interest rate resets, which are right now at an annual frequency, creating potentially a one-year lag in transmission, can be changed on all floating rate loans to quarterly resets so that transmission would be much faster once the monetary policy changes.” RBI will take a final view of the recommendations of the study group after taking into account the feedback received until October 25, 2017.