RBI announces new norms for banks to set lending rates

The Reserve Bank of India today released the final guidelines on computing interest rates on advances based on the marginal cost of funds. The guidelines come into effect from 1 April 2016.

Under the new rules, banks must set their lending rates every month on the basis of their marginal cost of funds, which will be based on the rate offered on new deposits.

The idea is to force banks to reflect market rates on the basis on deposit rates and rates prevailing in the money markets. The guidelines are also expected to ensure availability of bank credit at interest rates, which are fair to the borrowers as well as the banks.

Apart from helping improve the transmission of policy rates into the lending rates of banks, these measures are expected to improve transparency in the methodology followed by banks for determining interest rates on advances.

Further, marginal cost pricing of loans will help the banks become more competitive and enhance their long run value and contribution to economic growth, RBI said in a release.

As per the guidelines, all rupee loans sanctioned and credit limits renewed with effect from 1 April 2016 will be priced with reference to the Marginal Cost of Funds based Lending Rate (MCLR), which will be the internal benchmark for such purposes.

The MCLR will be a tenor-linked internal benchmark.

Actual lending rates will be determined by adding the components of spread to the MCLR.

Banks will review and publish their MCLR of different maturities every month on a pre-announced date.

Banks may specify interest reset dates on their floating rate loans. They will have the option to offer loans with reset dates linked either to the date of sanction of the loan/credit limits or to the date of review of MCLR.

The periodicity of reset will be one year or lower.

The MCLR prevailing on the day the loan is sanctioned will be applicable till the next reset date, irrespective of the changes in the benchmark during the interim period.

Existing loans and credit limits linked to the Base Rate may continue till repayment or renewal, as the case may be.

Existing borrowers will also have the option to move to the Marginal Cost of Funds based Lending Rate (MCLR) linked loan at mutually acceptable terms.

Banks will continue to review and publish Base Rate as hitherto.

Each month banks must also publish the benchmarks they use in setting their marginal cost of funds in order to improve transparency.

RBI governor Raghuram Rajan has repeatedly expressed his frustration over banks' reluctance to quickly lower their lending rates even as the central bank has aggressively eased its interest rates.

The RBI has cut its policy repo rate by 125 basis points since January, while banks have lowered their base lending rate by an average of 60 bps as of earlier this month.

Banks, however, say tracking deposit costs based on market rates can make lending rates too volatile, hurting their profit margins.

RBI exempted existing loans from the new lending rates, saying banks would not need to change lending rates for existing loans. The rules will only apply to new loans or to existing loans that are up for renewal, as long as the borrower agrees, it said.