RBI weighs linking all new loans to RBI's policy rates

Reserve Bank of India (RBI) is weighing plans to formally link all new bank loans to an external benchmark like the central bank's repo rate, in order to ensure that monetary policy changes acts as an economic impetus through transmission of rates, RBI governor Shaktikanta Das has said.

Das did not elaborate on the issue, but said it would issue guidelines on this.
“I think the time has now come to formalise the linking of the lending rates on new loans to external benchmarks like the repo rate. We are monitoring the developments in this regard and whatever steps are required in the coming weeks, will be taken by RBI," said Das, speaking at FIBAC, a banking conclave organised by the Indian Banks’ Association (IBA) and industry body FICCI.
RBI’s earlier efforts to formalise policy rate had met with opposition from banks which currently price their loans against their marginal cost of funds-based lending rate (MCLR).
In December last year, when Urjit Patel was the governor, the central bank had asked banks to set their interest rates for new loans, mainly retail loans, against an external benchmark beginning 1 April. Banks, however, raised concerns over lending at low rates. Banks fear that while low lending rates would attract borrowers, low deposit rates would deter depositors, putting banks in a dilemma.
The new rule was supposed to apply to all new retail loans and small business loans with floating rates. However, Das was forced to postpone the move and decided to hold consultations with stakeholders on it. 
Currently, banks price their loans against their marginal cost of funds-based lending rate (MCLR).
“We have kept the external benchmark (guidelines) in abeyance because we wanted to see how the market evolves. It is a positive trend that the banks have responded but this process needs to be faster," he said.
The governor said as against a repo rate cut of 75 bps by RBI (excluding the 35 bps cut in August) in 2019, the transmission was 29 bps and it was certainly not up to RBI’s expectations.
“It (transmission) should be, and can be better," he said.
He added that since the last meeting of the monetary policy committee (MPC), many banks have announced initiatives to link their new loans to the repo rate.
“Our expectation is that they should move faster," said Das. The RBI, he said, was constantly engaged with banks with regard to faster and greater transmission of monetary policy rates.
“The RBI will definitely pay its role as the regulator to work with the banks to see the trends in the market and take steps that can formalise these linking of new loans to repo rate or other external benchmarks," he said.
In India, the credit market is dominated by the banking sector which plays a key role in financial intermediation in the economy. Soundness of the banking system may have a bearing on the financial stability through various channels, Das pointed out.
Even if individual institutions are robust, the overall behaviour of the financial sector can pose a systemic risk. Hence, monitoring the health of the banking sector is crucial for financial stability, he added.
Meanwhile, RBI has taken cognisance of the build-up of risks among regulated entities due to interconnectedness, exposure concentrations, non-transparent market practices, governance deficiencies, and their contagion effects have repercussions for financial stability. 
He said the Reserve Bank is keeping a close watch on the interconnectedness of banks and non-banks. The Working Group on Core Investment Companies (CICs) has already started its deliberations and based on its recommendations, the Reserve Bank proposes to carry out necessary changes in the regulatory architecture for CICs. 
RBI, he said, is also in the process of building a specialised regulatory and supervisory cadre for regulation and supervision of banks and non-banks.