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A panel set up by RBI suggested that banks’ lending rates should be linked to external benchmark

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The Reserve Bank of India (RBI), on July 4, 2017, recommended linking bank lending rates to a market benchmark. The aim is to transmit monetary policy and improve transparency in rate setting by lenders. These lending rates will be linked to three external benchmarks – Treasury Bill rates, CD (Certificates of deposit) and RBI’s policy repo rate, which would come into effective from April 1, 2018.

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What does RBI's statement say?

Arbitrariness in calculating the base rate and MCLR, and spreads charged over them has undermined the integrity of the interest rate setting process.

Addressing the matter of internal benchmarks, Deputy Governor, Viral Acharya said, “We think that the internal benchmarks like the base rate or the MCLR, based on data, seem to give banks a very high amount of discretion lot of factors that are flexible for them to ensure that lending rates can be kept high even when monetary policy rates are going down an accommodative path.”

What the report says

After carefully analysing the pros and cons of 13 possible candidates as a benchmark, the Study Group narrowed down its choice to three rates mentioned below.

a. The Treasury Bill (T-Bill) rates

b. The Certificate of Deposits (CD) rates

c. The Reserve Bank’s policy repo rate.

The T-Bill rate and the CD rate were further assessed on three parameters, viz., (i) correlation with the policy rate; (ii) stability; and (iii) liquidity.”

Related: Banks to cut interest rates on savings accounts. What does that mean for you?

 

What did panel suggest?

It also suggested that banks would be banned if they charge conversion fee, in case they reset the rate of interest.

Janak Raj also said that internal benchmarks like base rate or MCLR (Marginal Cost Based Lending Rate) have not delivered effective transmission of monetary policy.

However, the Study Group did find some hindrances. These include:

  • Maturity mismatch and interest rate risk in fixed deposits, but floating rate loan profile of banks
  • Rigidity in saving deposit interest rates
  • Competition from other financial saving instruments
  • Deterioration in the health of the banking sector

Related: RBI cuts repo rate by 25 basis points

Who will it benefit from the changes?

Home loan and personal loan borrowers will now be on par with big corporates because interest rates charged on borrowers will be synced with global practices.

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