RBI examining suggestions on move to external benchmarking of loans, says Viral Acharya

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Mumbai: The Reserve Bank of India (RBI), which is examining the study group’s recommendation on external benchmarking of loan rates, will take a considered view, at an appropriate time, factoring the transition cost of moving to the new system, said Viral Acharya, deputy governor of the central bank.

“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. 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,” Acharya said in speech on Thursday.

The speech was uploaded on the central bank’s website late Thursday.

In October, a committee set up by the central bank recommended linking bank lending rates to a market benchmark in a bid to hasten monetary policy transmission as well as to improve transparency in rate setting by lenders.

The panel—headed by Janak Raj, principal adviser, monetary policy department—recommended that all floating rate loans advanced from April be referenced to one of the three external benchmarks. The panel has 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 as other factors such as maturity of the loan are being equal.

“As market rates normally move in line with the central bank’s policy rate, an external benchmark is globally considered and adopted as more appropriate than an internal benchmark for transmitting monetary policy signals,” he said.

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, internal benchmark reflects banks’ cost of funds, and second, until recently, it has been perceived that there have not been any robust and vibrant external benchmarks.

Since April 2016, banks moved to marginal cost of fund-based lending rate (MCLR) system as the previous regime of base rate was found to be rigid and weak for rate transmission.

Acharya said that muted transmission of policy rates into lending rates has been because of two broad factors—rigidity in pricing of bank deposits and deteriorating asset quality.

Rajnish Kumar, chairman of State Bank of India (SBI), said that for effective transmission, both sides of the balance sheet must be taken care of.

“The fact is that for banks in India, retail deposits constitute a very high portion of deposits and we cannot transmit rates to such a large section of retail depositors. We will also have to find ways and means on how do we take care of this aspect. But if any new system comes in, we will ready ourselves for the new system… If regulators decide that all loans have to be linked to external benchmarks, then to what extent deposits can be linked to external benchmarks, that is something which we will have to deliberate,” he said on the sidelines of an event on Friday.