The Reserve Bank of India has mandatorily asked banks to link their loan products to key repo rates or external benchmarks. The change will come into effect from October 1, 2019. The move will make home loans and auto loans cheaper from October onward as the banks will now be forced to pass on the multiple rate cuts the RBI has made in recent monetary policy meetings.
"Based on the consultations with stakeholders, it has now been decided to link all new floating rate personal or retail loans (housing, auto, etc.) and floating rate loans to Micro and Small Enterprises extended by banks with effect from October 01, 2019 to external benchmarks," the RBI said in a statement.
Banks have been given the option to choose the external benchmarks, which include policy repo rate decided by the monetary policy committee (MPC). The other two benchmarks include Government of India's 3-month and 6-month treasury bill yields published by the Financial Benchmarks India Private Ltd (FBIL). The banks can also use any other benchmark market interest rate published by the FBIL.
However, a bank will not be allowed to adopt multiple benchmarks within a single loan category. This limitation has been introduced to maintain transparency. Morevoer, banks are free to decide the spread under external benchmark, but the repo-linked interest rates have to be reset at least once in three months, RBI said in its statement.
"However, credit risk premium may undergo change only when borrower's credit assessment undergoes a substantial change, as agreed upon in the loan contract. Further, other components of spread including operating cost could be altered once in three years," the central bank stated.
Additionally, the decision is not exclusive to new loans, and banks are free to provide the benefit of external benchmark-linked loan to other borrowers as per their discretion.
The government has been pushing banks to link their loan interest rates to external benchmarks to ensure smoother transmission of changes in repo rates. The MPC has reduced the repo rate by 2.6 per cent since 2014, but the banks have reduced their lending rates by as low as 1.1 per cent during this period, keeping the benefits of the rate cuts from their customers.
Announcing the first tranche of measures to remedy the slump in economy, Finance Minister Nirmala Sitharaman had said that the banks have agreed to link their loan products. In the following days, several banks did link their certain loan products to repo rates, bringing down the interest rate on them. State Bank of India, Indian Bank, IDBI Bank, are among the dozen banks that have linked their lending rates to external benchmarks.
Amid deepening economic slowdown, the government has announced several measures to rejuvenate the economy, which include asking banks to link their lending rates, four mega mergers of 10 state-owned banks, various steps to help the struggling auto sector and more.