RBI may allow market-linked pricing of loans

The Reserve Bank of India (RBI) is expected to allow banks to charge interest rates linked to the marginal cost of funds as it moves ahead with moves to ensure faster transmission of rate revision to banks' customers. The proposed guidelines, allowing dynamic pricing of loans, are likely to benefit new customers.

RBI is reported to be seriously following up a suggestion made by some banks on pricing of loans on the basis of market-linked yields, with a clause for reset every quarter or year. The central bank is set to release its final guidelines on computation of banks' base rates on the basis of marginal cost of funds, possibly for the coming financial year.

It is, however, not clear whether the rates to be charged will be a moving one – to be calculated on a daily, monthly or quarterly basis – or inflation-linked, so that it would add some uncertainty to cost of funds for borrowers.

At any rate, dynamic pricing of loans will add uncertainty on the cost of borrowing for businesses, who will then look more to the bond market for working capital needs.

The dynamic pricing model may not apply to retail customers who will have some uniform pricing protection, although bigger loans may be shifted to the variable-rate regime.

Also, it is likely that banks will try to reduce their fund costs by lowering deposit rates, which are some of the highest among developing countries. Also, fund costs vary from bank to bank, and RBI cannot prescribe a uniform formula without taking fund sources into consideration.

Some banks want a duel pricing of loans. They have recommended keeping the current base rate formula while introducing a new dynamic reference rate. Accordingly, all new loans will be priced on the basis of the new dynamic reference rate.

However, they have recommended an immediate repricing of older loans as the borrowers will have not have borne the real costs of borrowing until they pay up.

Since the new reference rate is likely to change frequently with cost of funds coming down, banks have suggested fixing of a reference rate. They also want loan rates to be fixed after adding the spread on the basis of the customer's risk profile.

RBI has lowered the repo rate by 125 basis points so far this calendar year. But banks have cut their lending rates by only 60-70 basis points. The central bank hopes to achieve a better transmission of rate cuts by moving to the marginal cost of funds formula for calculating the base rate of banks.

Marginal cost of funds is an incremental cost of borrowing more money to fund assets or investments. Banks were hesitant on such a shift and had been taking the average cost to calculate the cost of funds.

Considering that a major part of the banks' funds are low-cost current and savings account deposits, most banks pay four per cent on savings account deposits, which account for 20-40 per cent of their total deposits.