Reserve Bank of India (RBI) is determined to go ahead with the linkage of bank lending rates with external benchmarks and is also studying the possibility of mandating non-banking finance companies (NBFCs), people familiar with the matter said.

Earlier this month, RBI made it mandatory for banks to link all new floating rate loans to micro and small enterprises (MSME) and loans to buy homes, vehicles and for personal consumption to an external interest rate benchmark from October 1. Banks can link their interest rates to the RBI's benchmark repo rate, the three month or six month treasury yield published by Financial Benchmarks India Pvt Ltd (FIBIL) or any other benchmark published by FIBIL, RBI said.

This plan was earlier envisaged to be effective from April 1 but was delayed after requests from banks to give them more time to adjust to the new regime. Last month, governor Shaktikanta Das announced that the central bank is ready to move to an external benchmark because it will help in more accurate transmission of interest rates. Subsequently, a circular was issued on September 4 linking select bank lending rates to an external benchmark.

"That decision has been made. It is a direction and will be implemented on October 1," said one of the people cited above. "We are also studying the possibility of linking NBFC lending rates to an external benchmark but there is no such proposal right now," this person added.

The central bank will first look at the experience with banks before extending it to NBFCs who are currently still calculating their benchmark interest rates based on the prime lending rates (PLR) even as banks, on the direction of the RBI, have since moved from PLR to base rate to a formula based marginal cost of lending rate (MCLR).

"The base rate was linked to average costs and dictated the rates. We wanted marginal changes to have a greater impact on rates and so moved to MCLR. In the MCLR regime, banks were free to include their business strategy and other costs in the anchor rate. In the new external-linked rate, these costs are part of the spread that banks make and are not part of the anchor rate, which is more transparent," said this person.

RBI is hoping that the new rate regime will fasten central bank rate actions and also remove discretionary elements from a bank's rate setting decision. RBI is hoping that once the costs of a bank are taken outside the benchmark rate, it will make pricing of rates more effective.

However, the cost of deposits have been kept out of the rate calculations and could impact transmission. RBI is hoping that competition between banks will make sure that the spread they charge over the anchor rate is not too high. #casansaar (Source - PTI, Economic Times)