RBI weighing plan to link loan rates to an external benchmark
MUMBAI:
The Reserve Bank of India (RBI) will decide on a proposal to link loan rates to an external benchmark after factoring in the transition cost of moving to a new system, deputy governor Viral Acharya said.
In October, a committee set up by the central bank recommended linking bank lending rates to a market benchmark to hasten monetary policy transmission to bank interest rates and improve transparency in rate setting by lenders.
“Over the past two decades, it has been the endeavour of the Reserve Bank to strengthen the monetary transmission process; but these efforts have yet not yielded the desired results,” Acharya said in a speech on Thursday. “The transmission from the policy repo rate to bank lending rates, which is the dominant transmission channel in India, has remained a matter of concern .” The speech was posted on the central bank’s website late on Thursday.
Monetary policy transmission is the process by which commercial bank interest rates are influenced by the central bank’s policy decisions. In the past, banks have faced flak for being slow to pass on central bank interest rate cuts to their borrowers.
The RBI panel headed by Janak Raj, principal adviser, monetary policy department, recommended that all floating rate loans advanced from April 2018 be referenced to one of three benchmarks. The panel suggested a risk-free curve involving rates on treasury bills, or certificates of deposit rates or the central bank’s policy repo rate.
According to Acharya, the virtue of an external loan benchmark is that it is transparent and common across banks. It allows borrowers to compare various loan offers by simply comparing spreads over the benchmark, other factors such as maturity of the loan being equal.
He added that in India, while banks have the flexibility to use both internal and external benchmarks, they seem to have preferred internal benchmarks for two main reasons. First, an internal benchmark reflects banks’ cost of funds and, second, until recently, it was perceived that robust and vibrant external benchmarks are absent.