The Reserve Bank of India (RBI) has proposed a major change in the way banks price their loans. It said that banks will now have to link the interest rates charged by them on different categories of loans to the external benchmarks instead of the used internal benchmarks.
Currently, all loans such as for car and home disbursed are linked to marginal cost of funds-based lending rate (MCLR).MCLR is an internal benchmark rate that depends on various factors such as fixed deposit rates, source of funds and savings rate.The price of loan comprises the MCLR and the spread or the bank’s profit margin.The biggest problem with the current system is lack of required transmission of policy rates to the borrowers
The RBI has given these options to banks for external benchmark: (a) RBI repo rate (b) 91-day T-bill yield (c)182-day T-bill yield or (d)any other benchmark market interest rate produced by the Financial Benchmarks India Pvt. Ltd.One of these benchmarks will be used to decide the lending rate in addition to the spread.Most commercial banks are likely to select RBI’s repo rate as it is the most stable one.
Repo rate is the interest rate at which the RBI lends money to commercial banks.Treasury Bills or T-bills are government bonds or debt securities with maturity of less than a year.Further,Spread refers to the difference in borrowing rates and lending rates of financial institutions.