Mandatory benchmark linking a good move

Communication of any relaxation in lending rates is one of the cornerstones of the monetary policy of the Reserve Bank of India (RBI). One reason for this is that unless the benefit of any relaxation in rates reaches the end consumer (usually retail borrowers and small and medium enterprises), the usefulness of such relaxations is moot. To ensure effective communication, the RBI has introduced various mechanisms such as the base rate methodology to replace the prime- lending rate, and the marginal cost of lending rate (MCLR) methodology to replace the base rate.

The RBI’s internal working group submitted its report on the working of the MCLR methodology in October 2017, and one of its recommendations included linking loan rates to external benchmarks to ensure more effective application of monetary policy measures of the RBI. Subsequently, the RBI’s statement on developmental and regulatory policies of December 2018 referred to the report and proposed to link all floating rate loans to retail, and micro, small and medium enterprises (MSMEs) to certain specified external benchmarks. The RBI also proposed that the spread over the benchmark rate would remain unchanged through the maturity of the loan unless there was a substantial change in the borrower’s credit assessment. While the statement mentioned that final directions would be issued by December 2018, this was delayed until September 2019, probably to avoid any potential disruption due to India’s national elections and the resulting settling down period of the new government.

The September 2019 directions on external benchmark lending require that, from October 1, all new floating rate personal or retail loans (such as housing or auto loans), and all new floating rate loans to MSMEs by banks should be linked to the RBI’s repo rate, the government of India (GOI) 91-day treasury bill yield disseminated by Financial Benchmarks India Private Limited (FBIL), the GOI 182-day treasury bill yield disseminated by FBIL, or any other benchmark rate produced by FBIL. To ensure transparency and ease of understanding, the directions require banks to adopt a uniform benchmark within a loan category.

Sawant Singh and Aditya Bhargava are partners in the Mumbai office of Phoenix Legal.

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