RBI's New Guidelines for Bank Lending Rates to Improve Transparency and Efficiency

The Reserve Bank of India (RBI) has introduced new guidelines for bank lending rates, requiring all banks to calculate their base rate based on marginal cost of funds from April 1, 2016. This shift aims to improve the transmission of policy rates to lending rates, ensuring that interest rates are fair to both borrowers and banks. According to Vaibhav Agrawal, vice-president and head, research, Angel Broking Pvt. Ltd., the new guidelines will lead to faster transmission of policy rates to lending rates.

Key Takeaways:

• The RBI has reduced the repo rate by 125 basis points (bps) in four tranches, but bank lending rates have only moved lower by a median 60 bps.
• The new guidelines require banks to calculate their base rate based on marginal cost of funds, which includes marginal cost of borrowings, return on net worth, operating costs, and tenor premium.
• The marginal cost of funds would be arrived at using average rates at which funds were raised in the last one month (or a quarter) preceding the date of review.
• Banks will have to publish their benchmark rates for multiple tenor loans, ranging from overnight to one year, on a monthly basis.
• The new guidelines will reduce pressure on the banks' net interest margins, stated Moody's Credit Outlook report.
• Existing loans will continue to be priced on a base rate until they are repaid or renewed, giving banks time to transition to the new methodology without affecting their net interest margins.
• Banks have been given an option to offer floating loans with reset dates linked either to the loan sanction date or the date of MCLR review.
• The interval between rate resets of up to one year provides banks an additional layer of flexibility to align overall portfolio lending rates and overall portfolio deposit costs.

Statistics:

• The RBI has cut the repo rate by a total of 125 bps in four tranches.
• Bank lending rates have only moved lower by a median 60 bps.
• The new guidelines require banks to calculate their base rate based on marginal cost of funds, which includes:

+ Marginal cost of borrowings: 6.5% (as of now)

+ Return on net worth: 4% (as of now)

+ Operating costs: 10% (as of now)

+ Tenor premium: 5% (as of now)

• The marginal cost of funds would be arrived at using average rates at which funds were raised in the last one month (or a quarter) preceding the date of review.

Sources:

• Reserve Bank of India (RBI)
• ICRA Research Services
• Mint Money
• Angel Broking Pvt. Ltd.
• ICRA Research report
• Moody's Credit Outlook report
• Religare Research report
• Prabhudas Lilladher Pvt. Ltd.
• SBI Capital Markets Ltd.