External benchmarks for loans may lead to face-off between banks, NBFCs

Banks are to link retail loans to external benchmarks; finance companies may be next

Is another whammy on the cards for non-banking finance companies (NBFCs)—this time on the issue of external benchmarks in the pricing of retail loans? It’s a matter which has come into the spotlight with the Reserve Bank of India (RBI) making it clear that NBFCs dependence on short-term liquidity will be a thing of the past even as banks have been asked to link their retail book pricing to the repo rate, the 91-day or the 182-day treasury bill yield; or any other market rate produced by the Financial Benchmarks India.

The chatter in the financial markets is that going by the guidelines that come into effect from the start of the new financial year, banks are at a distinct disadvantage vis-à-vis NBFCs, when it comes to retail loans. 

The primary reason why the RBI has moved on this front, when it comes to banks, is that customers were not getting the relief of rate cuts as the transmission effect has been weak. This is despite several attempts to have a quicker pass-through of rates since April 1, 2016 — through the marginal cost of funds-based lending rate; and still earlier when linked to the benchmark prime lending rate; and the prime lending rate.

“The RBI has introduced external benchmarks to which the interest rates would be tied, so that the effect of rate changes are transmitted to the customers directly. The external benchmark rates will be more aligned to market rates and therefore, could result in better transmission of RBI’s policy rate actions. Although the external benchmark rates would be transparent, they could also be volatile, which means customers’ equated monthly instalments may change more frequently,” said Navin Chandani, chief business development officer at BankBazaar.

What irks bankers is that at a time when parity is being sought to be established on the regulatory front between banks and NBFCs, the latter gets to price their retail loans differently — which is not linked to external benchmarks.

RBI governor Shaktikanta Das, in the just released bi-annual Financial Stability Report (FSR), has said that recent developments in the NBFCs sector have underscored the need for greater prudence in risk-taking. That, there is a need for some rebalancing as excessive credit growth, especially if funded with short-term financing, is not stability-enhancing. 

The assets of NBFCs grew to Rs  26 trillion by September 2018 from Rs  19.7 trillion in March 2017, up by Rs 6 trillion in a matter of just 18 months, the RBI Report of Trend and Progress of Banking (2017-18) had noted. The key driver of the growth in NBFC credit was the slowdown in bank credit growth. This was especially true of their lending to commercial real estate, consumer durables, and vehicle loans. 

“If you are to tighten the way they (NBFCs) source funds and the way they price risk, why then this treatment,” asks a banker on the condition of anonymity who adds: “What’s not clear is how do you cap an uptick if the rates are linked to market instruments like the T-bill. Just how far can retail loan pricing move up in that case.” Dhaval Kapadia, Director-Portfolio Specialist at Morningstar points to the fact that the RBI has made it clear that “the spread over the benchmark rate—to be decided wholly at the banks’ discretion—should remain unchanged through the life of the loan subject to certain factors.” The definition of “certain factors” has not been made clear as yet.

Broadly one could map the regulatory evolution in life of NBFCs and housing finance companies in three phases. First the early regulatory tightening of regulations after CRB Capital Markets scam in 1997; the systematic efforts to shape activities based on the Usha Thorat panel’s report on NBFCs in 2012; and of late, the blowout at Infrastructure Leasing & Financial Services.

Different yardsticks

• Banks claim the new external benchmark norms for retail loans place them at a disadvantage when compared to NBFCs

• The external benchmarks are the repo rate, the 91-day or the 182-day treasury-bill yield, or the market rate of the Financial Benchmarks India

• Move is to ensure customers get quicker relief, on the back of rate cuts

• The benchmarked rate is to hold through the life of the loan, subject to certain factors of which the definition has not been clarified

• Banks may lobby Mint Road to make benchmarks applicable to NBFCs as well; face-off on the cards