Repo Rate Linked Loans aka External Benchmark Based Lending​

Economy & Markets Loans & Funding

What is Repo Rate Linked Loans aka External Benchmark​ Based Lending directive by the Reserve Bank of India and how much it would be helpful in the fight against slowdown, explains the visual story.

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The RBI wide circular no. DBR.DIR.BC.No.14/13.03.00/2019-20 dated September 04, 2019 has directed all scheduled commercial banks (except regional rural banks), all small finance banks and all local area banks to charge lending rates on based on external benchmark from first of October’19.

“All new floating rate personal or retail loans (housing, auto, etc.) and floating rate loans to Micro and Small Enterprises extended by banks from October 01, 2019 shall be benchmarked to one of the following:

 – Reserve Bank of India policy repo rate

 – Government of India 3-Months Treasury Bill yield published by the Financial Benchmarks India Private Ltd (FBIL)

– Government of India 6-Months Treasury Bill yield published by the FBIL

– Any other benchmark market interest rate published by the FBIL.” reads the said RBI circular.

How new lending rates will be calculated?

Interest rates for lending under this regime will be a total of three, namely a) external benchmark, b)spread including operating costs and administrative costs etc., and c) credit risk premium calculated upon the borrower’s credit assessment.

Credit Risk Premium could only be changed with a change in the borrower’s credit assessment, not otherwise. ​Banks would only be able to alter the ‘Spread’ once in three years.​ Thus, banks would not be in a position to increase their margins with a change in policy rates and hold back transmission of monetary policy.

Under the existing systems of Base Rate/MCLR, it is up to the banks to change the lending rates with a change in monetary policy rates such as repo rates etc., but this directive will ensure the exact change in lending rates with a change in external benchmarks. The proposed external benchmarks such as repo rates, T-bill rates etc., are more or less controlled by the RBI directly.​ Thus, the transmission of monetary policy change will be more direct from now onwards. 

Would it help strenghting the economy against slowdown?

It will surely lower(or higher) the interest rates at the instance of RBI, but the main issue lies in the flow of credit from banks, not the cost of the same. As evident from the RBI’s annual report that shows a huge decline of Rs 1.7 trillion in non-food credit in the first quarter of this financial year.

Banks are sitting on a heap of bad loans and are also facing a capital shortage; one may argue easily. Gross NPAs of public sector banks has declined from Rs 8,95,601 crores as on 31.03.2018 to Rs 8,06,412 crores as on 31.03.2019 as per provisional figure shared by Govt. of India. Also, the Government has infused Rs 3.15 lakh crore in public sector banks in the last 11 years, as reported by Bloomberg[1].

​Whether it is the Kingfisher’s Mallya Case or the Neerav Modi case, the hyping of loan defaults by media has made bankers reluctant to take risks to a major extent. Further, blaming aggressive lending policies for NPAs by the current government makes the scene more shabby[2]. Instead of providing support and stimulating financing, the existing government seems more keen at blaming the predecessor for the NPAs even after elapse of six years in power. A loan account slips to NPA category by mere default of 90 days and generally, written-off within 3 to 5 years thereafter. Thus, all defaults happened during the last government should already have been written off as on date. Undoubtedly, financing has been hampered due to shaken confidence of bankers and need of the hour is backing bankers for risk-taking and safeguarding against media trials.

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