The Reserve Bank said on Wednesda that it will link the base rate with the Marginal Cost of Funds based Lending Rates (MCLR) from April 1 to ensure expeditious transmission of its policy rate to borrowers.
RBI introduced the MCLR system with effect from April 1, 2016 on account of the limitations of the Base Rate regime.
"With the introduction of the MCLR system, it was expected that the existing Base Rate linked credit exposures shall also migrate to MCLR system," RBI said in the statement on Developmental and Regulatory Policies.
It is observed, however, that a large proportion of bank loans continue to be linked to the Base Rate despite the Reserve Bank of India highlighting this concern in earlier monetary policy statements.
"Since MCLR is more sensitive to policy rate signals, it has been decided to harmonise the methodology of determining benchmark rates by linking the Base Rate to the MCLR with effect from April 1, 2018," it said.
RBI Deputy Governor NS Vishwanathan said: "We have been mentioning in the earlier policy that we are concerned about inadequacy of monetary transmission to the base rate and about large number of accounts still being under the base rate regime.
"We are now harmonising the calculation of base rate with the MCLR so that the responsiveness of the credit portfolio to monetary policy signals is not hindered by interest rate on large part of bank portfolio being linked to base rate. I want to again clarify that what we are doing is harmonising and we are not equalising the MCLR with base rate."
Former RBI governor Raghuram Rajan introduced the MCLR to calculate the benchmark lending rate in another attempt to make banks pass on policy rate cut benefits to borrowers quickly and in a more transparent manner.
Under the base rate and BPLR, banks were following individual methodologies for computing the minimum rate at which they could lend. Under the MCLR, RBI asked all banks to follow the marginal cost of funds method to arrive at their benchmark lending rate.
MCLR is calculated after factoring in banks' marginal cost of funds (largely, the interest at which they borrow money), return on equity (a measure of banks' profitability), and negative carry on account of cash reserve ratio.
RBI will issue necessary instructions in this regard by the end of next week.
The Reserve Bank of India (RBI) has on several occasions flayed lenders for keeping interest rates high and flagged concerns over base rate and marginal cost of fund-based lending rate (MCLR), saying these have not improved monetary transmission.
An internal RBI group also suggested switching over to an external benchmark in a time-bound manner so that better rates are available to borrowers.
An internal Study Group headed by Janak Raj, in its report observed that internal benchmarks such as the base rate and MCLR have not delivered effective transmission of monetary policy.
With a view to harmonising regulations across different types of collateral and also to encourage wider participation, especially for corporate debt repos, the repo directions are proposed to be streamlined and simplified.
The revised directions will be issued by the end of this month.
RBI said access to non-residents for hedging their rupee currency risk arising out of their current and capital account transactions is limited by the type of risks that are permitted to be hedged and the instruments that can be used.
"With a view to ease the access of such non-residents to the onshore market for their hedging requirements, including for Masala bond exposures, it is now proposed to allow them to dynamically hedge their currency and interest rate exposures onshore using any of the permitted instruments," it said.