Interesting, but risky
RBI’s diktat to banks could spur borrowing butmay pressure lenders’ marginsThe Reserve Bank of India (RBI) has finally decidedthat it needs to address the problem of inadequate interest rate transmission head on. In a circular to banks on Wednesday, it directed lenders to linkall new floating rate loans given to borrowers in the personal, retail and micro, small and medium enterprise(MSME) categories to external benchmarks, includingthe repo rate, with effect from October 1. While givingbanks the relative freedom to choose the specific external benchmark, including yields on the 3month and 6month Treasury Bills published by the Financial Benchmarks India Pvt. Ltd., the central bank made it clearthat lenders would need to adopt a uniform benchmarkwithin a loan category. Banks have also, crucially, beengiven the leeway to determine their spread over thebenchmark rate with a caveat that changes to the creditrisk premium can only be made when the borrower’scredit assessment undergoes a substantial change. Thatthe inadequate transmission of policy rate moves hasbeen an abiding conundrum for the RBI is well known.In 2015, then Governor Raghuram Rajan decided thatthe system used by banks to price their loans needed tobe changed and so introduced the Marginal Cost ofFunds based Lending Rate (MCLR) regime. In October2017, an internal study group of the RBI recommendedthe adoption of external benchmarks to ensure effective policy transmission, after observing that the MCLRtoo had failed to deliver.Policymakers, in fact, have been so vexed with poortransmission — against a total of 75 basis points (bps) reduction in the RBI’s repo rate between February andJune, the weighted average lending rate on fresh rupeeloans at banks eased only by 29 bps — that MonetaryPolicy Committee member Chetan Ghate in August cited the issue as reason to oppose the proposed 35bpscut and instead voted for a 25bps reduction. “By a largecut (35 bps) I feel we will be burning through monetarypolicy space without much to show for it. While the realeconomy needs some support, we should wait for moretransmission to happen,” he said at the MPC’s rate setting meeting, the minutes show. Though the latestmove will surely lower the interest cost on new floatingrate loans availed by borrowers to buy cars or homes, itmay force banks to start cutting the interest rate theypay deposit holders or risk seeing their margins shrink.And while the RBI wants to try and nudge an uptick incredit for becalmed personal consumption and borrowing by beleaguered MSMEs, the success of the measurewill ultimately be determined by a regaining of confidence by consumers to spend anda conviction by industry to invest.
