External benchmark-based lending must: RBI

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News:The Reserve Bank of India (RBI) has made it mandatory for banks to link all new floating rate personal or retail loans and floating rate loans to MSMEs to an external benchmark rate from October 1st,2019.

Facts:

  • The RBI has given the options to banks for external benchmark rates which are (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.
  • At present,interest rates on loans are linked to a bank’s marginal cost of fund-based interest rate(MCLR).
  • The biggest problem with the current system is the lack of required transmission of policy rates by the banks to the borrowers.

Additional Information:

Repo rate

  • Repo stands for ‘Repurchasing Option’.It refers to the rate at which commercial banks borrow money from the RBI.

T-bills

  • T-bills or treasury bills are short term securities issued on behalf of the government by the RBI and are used in managing short term liquidity needs of the government. 
  • The 91-day T-bills are auctioned every week on Wednesday and 182-day and 364-day T-bills are auctioned every alternate week on Wednesdays.T-bills are issued at a discount and are redeemed at par.

Marginal Cost of lending rate(MCLR)

  • The marginal cost of funds based lending rate (MCLR) refers to the minimum interest rate of a bank below which it cannot lend except in some cases allowed by the RBI.It is an internal benchmark or reference rate for the bank.
  • This rate is based on four components namely (a)marginal cost of funds, (b)negative carry on account of cash reserve ratio (c)operating costs and (d)tenor premium.