Bankers cautious on new benchmark move

It will improve transparency and provide same set of benchmarks for financial sector and real sector

Welcoming the Reserve Bank of India’s (RBI’s) efforts to link market-determined benchmarks to price loans, bankers have said they preferred a gradual migration to new regime to develop aspects such as risk hedging tools to address asset-liability mismatches.

The current system — marginal cost of funds-based lending rate (MCLR) — is not far off from market-determined rates for loans. “While making frequent changes in rates for the asset side, we have to keep in mind the fact that deposits in India are predominantly on fixed rates. That builds rigidity, limiting room to manoeuvre,” said senior bankers across public, private and foreign banks.

The central bank’s move will improve transparency and provide the same set of benchmarks for the financial sector and the real sector (the borrowers), the bankers said. It will also help develop risk management tools, including derivatives. Ananath Narayan, regional head, financial markets (Asean & South Asia), Standard Chartered Bank, said at present the financial sector (such as banks) and the real sector (that is, the borrowers) looked at different sets of benchmarks to price loans. The market-determined rates regime will remove this difference, he said, adding the shift to new regime had to be done thoughtfully.

The RBI, at its monetary policy review on Wednesday, had said it was exploring ways to link bank lending rates directly to market-determined benchmarks. Though the MCLR system, which became operational from April 1, 2016, was an improvement over the base rate system, monetary transmission by banks was “not entirely satisfactory”, the central bank had said. The regulator said it had formed an internal group to review the working of the system to improve transmission.

Indranil Pan, chief economist, IDFC Bank, said the shift from the MCLR to a market-determined rates might be a thought in the right direction. But implementation challenges could come from the fact that different banks in India could have different cost structures for raising deposits.
 

Soumyajit Niyogi, associate director, Core Analytical Group, India Ratings, said a market-based lending rate could strengthen pricing of credit and enable developing of other financial products, particularly the securities markets.

However, there were two critical impediments: One, the liability side of Indian banks was more agnostic to markets; and two, the banks could weaken transmission even then since they invest in the largest bonds.

The RBI in December 2015, while nudging banks to move to the MCLR regime, had said for monetary transmission to occur, lending rates had to be sensitive to the policy rate.

With the introduction of the base rate on July 1, 2010, banks could set their actual lending rates on loans and advances with reference to this rate.