New retail benchmarks set by RBI likely to hit profitability of banks

Change in lending rate benchmark may not aid loan book growth but increase margin volatility

Though borrowers from retail and micro, small and medium enterprises (MSME) segments will benefit from the transparent and standard lending rate structure, the same will impact profitability of banks. 

The Reserve Bank of India (RBI) on Wednesday announced the linking of all new floating retail and MSME loans to external benchmarks such as RBI’s policy rate, and yields on 91 or 182-day government treasury bills (T-bills), from April 2019. “Profitability of banks may see higher volatility, unless they are able to raise floating rate deposits linked to external benchmarks,” says Karthik Srinivasan, senior vice-president at ICRA. 

The new benchmarks are more volatile and not in control of banks, and deposit rates are not linked to external benchmarks. Also, banks will not be allowed to change spread throughout the life of such loans unless there is significant change in credit assessment of borrowers. Spread is the rate charged by banks above the benchmark rate based on internal credit and risk policies. 

Whether banks can keep the reset clause (periodicity of reviewing interest rate on loan) in these cases is still unclear. Detailed guidelines will be out by December-end, according to the RBI.

Further, the new benchmark rates are lower than the existing benchmark rates. For instance, State Bank of India’s 3-month and 6-month MCRL is 8.20 per cent and 8.35 per cent, respectively, as compared to the 91-day T-bill yield of 6.73 per cent and 182-T-bill yield of 7 per cent, as of December 5. 

Further, analysts at ICICI Direct estimate up to 1.6 per cent impact on FY20 net profit of banks, assuming 12 per cent incremental growth in new floating rate loans and a 50-bps cut in the lending rate, led by external benchmarks. Banks with a higher proportion of home loans (SBI and BOB) are expected to be impacted more.

The new dispensation is unlikely to benefit borrowers and improve loan book growth as banks will increase spread (at the time of sanction) in order to keep lending rate at least at current levels. This, along with stiff competition, is unlikely to help accelerate loan book growth, said an analyst.