The Reserve Bank of India is planning a new system to facilitate policy rate transmission. Towards this end, the central bank's study group has suggested banks should switch over to a new interest rate calculation regime from the existing MCLR system. The group has recommended the T-Bill rate, the certificates of deposit (CD) rate and the RBI's policy repo rate - the rate at which the regulator lends to banks - are better suited than other interest rates to serve the role of an external benchmark.
The reason for the new suggestion is the RBI's unhappiness over the slow transmission of policy rates to borrowers. Over the years, the apex bank has tried at least four systems to ensure better transmission of rate to common man. But the banks have been able get around all these and ensure that their net interest margins are safe while deciding interest rates.
In the mid 1990s, a few years after that then finance minister Manmohan Singh opened up Indian economy, lending interest rates were deregulated. As part of this exercise, the RBI told banks to disclose their prime lending rates (PLRs) -- the interest rate charged for its creditworthy borrowers. Banks themselves wanted PLR to be converted into a reference/ benchmark rate and the BPLR was born in April 2003. The benchmark rate was announced by each bank after the approval of their respective boards.
BPLR was a benchmark rate or a rate at which banks lend to the best borrower. But most banks started keeping various BPLRs. For old customers, BPLR never changed. Meanwhile, new customers got new rates. In effect, even if you were on floating rate, the rate mostly did not come down even if the RBI cut policy rates. In short, the practice defeated the very purpose for which the BPLR system was introduced.
But by 2008-09, sticky BPLR made borrowers of floating rates home loans started feeling cheated. Their rates went up when the RBI raised rate, but did not fall when it cut rate. To deal with this opaque system, the apex bank decided to move to the base rate system effective 1 April 2010.
Banks were not allowed to lend below this benchmark. This was also supposed to be more transparent. Hence if market rates fell below the base rate, banks had no choice but to cut base rates to woo consumers. The banks needed to take into account their cost of funds, overheads, plus other factors to arrive at the base rate. On top of the base rate, banks could charge a spread. According to this report in the Business Standard, the new system managed to decrease the discrimination between old and new customers.
But banks still found a way to get around. They would keep the base rate but cut the mark-up if required. And any such change in rates was, again, mostly applicable to only the new borrowers while the existing ones continued to pay the higher old rate. Thus base rate became as murky as the earlier BPLR. Banks argued changing the base rate was a major decision for them. They said there was no flexibility in determining the cost of funds – average, marginal or blended cost. This rendered lending rate decision opaque and the assessment of monetary policy transmission difficult.
By April 2016, the central bank had yet another solution. It instituted a new lending rate system for banks – the marginal cost of funds-based lending rate (MCLR) system with a view to improving transmission. However, the actual experience of MCLR was pretty poor too. Unlike the BPLR and the base rate, the formula for computing the MCLR was prescribed by the RBI. As per this RBI report, banks deviated in an ad hoc manner from the specified methodologies for calculating the base rate and the MCLR to either inflate the base rate or prevent the base rate from falling in line with the cost of funds. Moreover, banks also often changed their spread over MCLR to protect their margins, defeating the purpose of introducing a transparent formula. In short, MCLR too failed to give effective transmission of policy rates.
It is in this context the study group last week suggested banks should switch over to a new interest rate calculation regime.
The group has recommended the T-Bill rate, the certificates of deposit (CD) rate and the RBI's policy repo rate are better suited than other interest rates to serve the role of an external benchmark.
"The T-bill rates are risk-free and also transparent. They also have a reliable term money market curve. CD rates relate to the credit market directly in the sense that banks could meet their marginal requirement of funds from this market. CDs also have a reliable, term money market curve," the report said. Internationally, a transparent third-party benchmark is used as a reference rate for loans.
The report recommended adoption of external benchmark from 1 April 2018. The public can submit their comments on the suggestion made to the RBI.
The Reserve Bank has stated that the comments on the report may be sent to then via email email@example.com by by October 25, 2017.
The real issue
The problem with the banks' interest rate setting system has been that consumers are given short shrift. Banks are always more interested in protecting their net interest margins than offering their customers a better deal.
The RBI study report clearly states, “Analysis conducted by the Study Group suggests that banks deviated in an ad hoc manner from the specified methodologies for calculating the base rate and the MCLR to either inflate the base rate or prevent the base rate from falling in line with the cost of funds.”
Suresh Sadagopan, a Mumbai-based certified financial planners feels the getting an external benchmark will be better suited than MCLR or base rate. However, he also says putting a new system in place may not the solution for banks not complying with a guideline.
“The real issue here is compliance. It is clear that a number of banks haven’t complied with the formula, neither in letter nor in spirit. The RBI should penalise the banks which have not complied with the guidelines," he says.
Another personal finance expert, who was also a former banker, also says the banking regulator should crack the whip. “Read the RBI report and you will see that banks are cheating. Instead of penalising the banks, it is bringing in another rate system," he says.
"I am not saying the new system is bad. In fact, it’s better that it will be a third-party benchmark. But, if banks are openly and blatantly cheating. Why would you expect anything to change in the future? More importantly, the RBI is bringing the new system for better policy transmission, not because the customer will get better deal," he says.
In short, third-party benchmark may be a move in the right direction if its gets implemented. However, only time will tell if it will make any difference for customers. Meanwhile, what you, the customer, can do is send in your suggestions if any to the central. Remember, the RBI should get them before 25 October.
Updated Date: Oct 09, 2017 15:58 PM