External benchmark for floating rate loans from October 1

External benchmark for floating rate loans from October 1”

Some bankers and analysts warned that rates may either rise in the short term or stay where they are, as banks' cost of funds is linked to deposit rates that are sticky and not benchmarked.

The three external benchmarks the RBI proposed are policy repo rate, the Government of India's three-month and six-month treasury bill yields published by Financial Benchmarks India Private (FBIL), or any other benchmark market interest rate published by FBIL.

The norms for external benchmark linking of interest rates was scheduled to be operational from April 1, but was deferred. The certainty that retail borrowers look for in EMIs will go. If a bank is facing a liquidity crunch it is unlikely that it will lower deposit rates in a hurry, even when the RBI reduces its policy rate - as was the case in 2013. For instance, SBI's home loan rate dropped to 8.05% after it linked its advances to the repo rate which is almost half a percentage point lower than the 8.55% it charged customers in June under the marginal cost of lending rate (MCLR).

In a bid to spur demand in auto and housing sector, Reserve Bank of India (RBI) has made mandatory for banks to link all their fresh retail loans to an external benchmark, effective October 1. The move is aimed at making banks transmit the RBI's interest rate actions. The reverse, however, doesn't happen as promptly. The historic low for the repo rate is 4.75% which is 65 bps lower than the current rate of 5.4%.

While banks are free to decide on the spread over the external benchmark, credit risk premium can change only when borrower's credit assessment undergoes a substantial change, the RBI said, adding other components of spread, including operating cost, could be altered once in three years.

"There shall be no lending below the benchmark rate for a particular maturity for all loans linked to that benchmark", the central bank said. A basis point is one-hundredth of a percentage point. The fall may be just 20 bps or 10 bps, depending on the strength of the bank's deposits franchise. Eventually, instead of giving out the home loan at 10%, the bank may offer it at 10.2% or 10.3%.

"The final rate charged to this category of borrowers, after switchover to external benchmark, shall be same as the rate charged for a new loan of the same category, type, tenor and amount, at the time of origination of the loan", the RBI said. But to ease depositors' pain, the bank had retained the earlier 3 per cent rate on such deposits. For Axis Bank, every 200 bps change in interest rates will impact its earnings by ₹1,665 crore. The historic high is however 9% which is 360 bps higher than current rates. This further lowers banks' ability to manage rate risk. "However, the same swiftness in transmission of reduced repo rates or other external benchmarks can work against borrowers as the interest rates would increase faster vis-a-vis MCLR-based ones during a rising interest rate regime", says Naveen Kukreja - CEO& Co-founder, "The bigger issue is that of banks' ALM (asset-liability management) over the longer term in the absence of floating rate liability market". "Large HFCs like HDFC, LIC HF and PNB HF compete with banks closely in their retail home loan segment and will need to catch up with their banking peers on any movement in home loan rates", said M B Mahesh, analyst, Kotak Institutional Equities Research. It will also slow down transmission till all rates are aligned, and could lead to tweaks in bank spread or credit risk adjustment.

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