Benchmarking lending will translate into good times ahead for borrowers
Less than a month after the third
bi-monthly Monetary Policy Statement for FY2019-20 (August 2019)was announced,
the RBI made it mandatory for banks to link all their fresh retail loans to an
external benchmark, effective October 1, 2019. The central bank suggested that
this benchmark rate could be the RBI’s policy repo rate, the Government of
India’s three-month and six-month treasury bill yields published by the
Financial Benchmarks India Private (FBIL), or any other benchmark market
interest rate published by FBIL.
The reason cited for this mandate was,
“it has been observed that due to various reasons, the transmission of policy
rate changes to the lending rate of banks under the current MCLR framework has
not been satisfactory”.
The RBI has been referring to the
financial sector’s response to its rate movements as the ‘transmission’ of the
policy action. Until recently, it has been disappointed with the response of
various financial market participants. However, during the most recent MPC meet,
the RBI governor remarked, “The transmission of policy repo rate cuts to the
weighted average lending rates (WALRs) on fresh rupee loans of banks has
improved marginally since the last meeting of the MPC. Overall, banks reduced
their WALR on fresh rupee loans by 29 bps during the current easing phase so
far (February-June 2019).” But apparently, this was not good enough.
RBI rates on a downtrend
August 2019Monetary Policy Committee (MPC),the RBI reduced the repo rate by 35
bps to 5.4%. This was the fourth consecutive repo rate cut since the beginning
of the calendar year. More pertinently, the MPCdecided to maintain the accommodative stance of the monetary policy.
Repo rate has been cut 4 times since January 2019
The rate cut was not unexpected. The
MPC has been working its broad mandate to ‘keep the medium-term target for
consumer price index (CPI) inflation at around 4% (within a band of +/-2) while
supporting growth’. Both domestic and international macro-economic variables
called for a rate cut.
US Federal Reserve has cut its benchmark rate after a decade.
economic activity has slowed and trade and geo-political tensions have
growth in leading emerging economies outside India – China, Russia, Brazil and
South Africa – is flagging.
oil prices have dipped since May 2019 while the price of Gold and Silver have
begun to rise.
Growth has dipped to a five year low of 5.8% and the MPC has reduced its growth
forecast for FY2019-20 from 7.0 per cent (projected in June 2019) to a range of
6.4-6.7% for H1 FY2019-20 and 7.2-7.5% for H2 FY2019-20.
inflation has remained below 4% for over a year, giving the RBI the elbow room
to reduce interest rates.
activity has moderated and business investments are sluggish.
To give a fillip to the economic
scenario without compromising inflation control, the MPC – as expected by
markets and economists – reduced the repo rate and stays committed to a dovish
Implications of better transmission in a reducing rate scenario
When the RBI led with a rate cut,
until now, it simply sent out a signal to the financial sector that institutions
should reduce their rates too. The transmission was expected to follow as the
RBI facilitated banks and NBFCs by cutting its rate and thereby, to some
extent, enabling them to access funds at a lower rate. It could not, however, mandate
that the financial sector ‘must’ cut their rates too.
With this new mandate, banks can
choose their benchmark and will still be free to decide the spread over the
external benchmark. However, it will ensure transparency, standardisation and
ease of understanding of loan products by borrowers.
In the months ahead, borrowers can
look forward to lower rates of interest that translate into smaller EMIs or
shorter terms or other positive credit indicators. At the same time, due to
various measures by the RBI to strengthen the position of lenders, they can
look forward to more streamlined risk management and more robust financial