The Reserve Bank of India(RBI) is considering asking banks to link loans to an external benchmark such as the repo rate to improve transmission of policy rates and foster economic growth.
Repo stands for ‘Repurchasing Option’.It refers to the rate at which commercial banks borrow money from the RBI.
Currently,bank loans 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.Spread refers to the difference in borrowing rates and lending rates of financial institutions.
The biggest problem with the current system is the lack of required transmission of policy rates to the borrowers.
However,several banks such as State Bank of India(SBI) had already introduced a repo rate-linked loan from July 1,2019.