Indian two thousand and five hundred rupee banknotes are arranged for a photograph in Mumbai, India. (Photographer: Dhiraj Singh/Bloomberg)  

Bankers Seek To Quash External Benchmarking For Retail Loans

No one likes change. Least of all India’s bankers.

A directive by the Reserve Bank of India asking banks to start linking floating retail loans to an external benchmark starting April 2019 is facing stiff opposition from the country’s lenders.

The Indian Banks’ Association is seeking time with Reserve Bank of India Deputy Governor, NS Vishwanathan to ask the regulator to defer the implementation of external benchmark-linked rates on all floating rate retail loans, five bankers in the know told BloombergQuint. The association, a lobby body for the sector, has sought a meeting to discuss issues with implementing the new framework, these bankers said.

According to the bankers quoted above, the banking sector is against introducing a new interest rate regime for retail loans. As such, bankers will suggest that external benchmark-linked lending rate can be introduced for corporate loans to begin with.

The banking sector, including representatives from the IBA, have already flagged off this issue to RBI Governor Shaktikanta Das in their meeting with him earlier this month. However, Das asked the bankers to meet with Deputy Governor Vishwanathan, so that their concerns can be addressed by the appropriate division.

The RBI had decided to introduce external benchmark linked loans after a long battle with poor transmission of monetary policy through banking channels. After experimenting with various formulas, the RBI has suggested using a external benchmark to determine movements in loan rates on retail floating rate products. Banks were given a choice of four benchmarks and were also given the freedom to fix the spread. The spread, however, would remain constant unless there was a change in the borrowers credit profile.

Bankers Seek To Quash External Benchmarking For Retail Loans

What Are Bankers Afraid Of?

According to the bankers quoted above, an external benchmark like the 91-day treasury bill, could lead to significant volatility in loan rates. In particular, home loan customers could be adversely impacted.

To prove their point, bankers have conducted a study of all home loan rates since 2016, which were priced under the marginal cost of funding based lending rate (MCLR), one of the five bankers quoted above said. Home loans are typically priced at a small premium over the six-month MCLR. In their study, bankers also calculated home loan rates using the 182-day treasury bill rates as their benchmark. A comparison of the MCLR and the external benchmark linked rates showed that the latter proved to be extremely volatile. On certain occasions, the external benchmark linked rate was about 100 basis points (bps) higher than the MCLR-linked rate.

This is because treasury bills are priced on the basis of liquidity, while MCLR allows averaging of a bank’s cost of funds, the first banker quoted above explained. Any rapid change in interest rates on long term loans could result in higher default rates, the banker added.

Banks are also arguing that deposits are currently not linked to a market-linked rate. Linking loans but not deposits could hurt banks, a second banker said.

A third banker said that the MCLR regime is as transparent as any external benchmark-linked regime since the banking regulator conducts regular audits of bank books. It is unfair to say that bankers are trying to artificially hold interest rates higher when there is a regular audit, this banker added.

What Does The RBI Say?

While the RBI is yet to grant bankers a meeting with the deputy governor, an internal committee report on external benchmarks had addressed some of the concerns.

In its report reviewing the MCLR regime, the RBI committee led by Janak Raj, principal adviser, monetary policy department, had noted that there is a need for a developed interest rate derivatives market to ensure that an external benchmark linked rate can be introduced. The derivatives market will allow banks to hedge any interest rate risk if the external benchmark rate displays undue volatility.

“The study group recommends that the corporates and banks be encouraged to actively manage interest rate risks once the external benchmark is introduced. It should also help deepen the IRS (interest rate swaps) market, going forward,” the committee report noted.

The committee had also suggested that banks could start offering bulk deposits linked to the external benchmark. This could help address the divergence between fixed deposit rates and floating lending rates.

The committee had noted in its report that the current MCLR regime lends itself to arbitrariness when calculating loan rates. Moreover, in the absence of a sunset clause for the older base rate regime, banks have not been forthcoming in moving their customers to MCLR-linked rates. Since most borrowers of the base rate regime were from the retail and small and medium enterprises segments, there has been a weak pass through of lower policy interest rates.

In its monetary policy announcement in December 2018, the central bank has asked banks to start with the external benchmark rate on loans from April 1, 2019. The RBI had said that it will be releasing its guidelines by the end of December. However, final guidelines are still pending.