The Reserve Bank of India is taking new steps to link all loans to external interest rate benchmarks. Once done, this step by the government will make both home and car loans more affordable.
What is the RBI Planning?
The external interest rate benchmarks will help the RBI create a more effective monetary policy. It will link the loans given to small and medium enterprises (MSMEs) to benchmarks. Not only this, but it will also affect loans for retail customers, which will include both home and car loans. Borrowing rates for personal travel are also expected to fall.
The central bank has also suggested a new series of interest rates that different lenders can choose as pegs. Note that growth in India has slumped this year. The June quarter reported the slowest rates of growth in six years. The apex bank has been prepared for the crisis and has already lowered its policy rates by 110 basis points (one basis point represents the 100th part of a percentage point). The Finance Minister Nirmala Sitharaman has also urged banks to make rate transmission more efficient. It is expected to drive consumer demand, investment and eventually credit expansion.
Banks Mandated to Make a Move
The new framework suggested by the RBI will come into effect on the 1st of next month. It will put an end to MCLR or Marginal Cost of Lending Rate that the institutions had been following till date. However, the RBI has not touched the risk premium charges. The banks are free to decide such charges depending on the credit profile of the borrower. The central bank, however, will not allow lenders to circumvent the system using the charges. The banks will not be able to change the risk premiums until there is a significant change in the credit profile of the debtor.
In a press release, the RBI noted,
“In order to ensure transparency, standardization, and ease of understanding of loan products by borrowers, a bank must adopt uniform external benchmark within a loan category.”
The lenders also need to reset their internet rates using external benchmarks every three months.
According to the RBI, the lenders can use its repo rate as a peg for defining new rates of interest. They will also be free to use benchmarks published by Financial Benchmarks India Ltd (FBIL). The institution publishes 3-month and 6-month Treasury yields, which will also qualify as external benchmarks for the purpose of defining interest rates.