Lobbying against external benchmark begins

After 20 years of allowing the open abuse of floating rate loans, on December 5, the Reserve Bank of India (RBI) announced that beginning April 1, 2019, banks would have to link interest rates on such loans to an external benchmark instead of using their own internal benchmark. This marks one of the few cases of pro-consumer action taken by the RBI. The RBI claims to strike a balance between banks and consumers, but usually bats for banks.

 

But lenders aren’t giving in so easily. They have started lobbying against the external benchmark, stressing “problems” in implementing the linking of an external benchmark rate to floating rate loans. To put the maximum weight behind their lobbying, bankers usually get a senior official from the government-owned behemoth State Bank of India (SBI), to speak on their behalf. On January 10, Prashant Kumar, deputy managing director and chief financial officer of State Bank of India, wrote an article in this paper, which argued strongly against the new RBI policy.

 

It turns out his arguments are rather tangential and mainly advocate retaining the status quo. He wants savers to continue to put money in savings banks at 4 per cent or less, which is very good for banks. He says adjusting the policy rate will not change the lending rate much because only 1 per cent of bank borrowings are currently at the policy rate. Three, current account and savings accounts (CASA) deposits account for 41 per cent of public deposits. Banks pay no money on the current account and an average of 3.5 per cent on the savings account. The rest are time deposits with a fixed interest rate. So, when the policy rate changes, there will be only a small change in deposit rates and thereby in lending rates. He then goes on to complain how the changeover is going to involve time and money, and how banks will make less money so things should continue as usual. The regulator, of course, ought to take a more balanced view including the interests of the consumers. From this perspective, here are two very important issues that Mr Kumar has missed or ignored.

 

Arbitrary calculations

 

The benefit of imposing an external benchmark is not just to make sure that every change in interest rates is transmitted. There are two other important benefits: Making the floating rate calculation transparent and stopping the discrimination between new and old borrowers, which was pioneered by SBI and followed by other banks. To understand the tremendous opacity in floating rates calculations by the banks, look at the RBI’s own internal study titled “Report of the Internal Study Group to Review the Working of the Marginal Cost of Funds Based Lending Rate (MCLR) System”, headed by Janak Raj.

 

The report points out that “banks deviated in an ad hoc manner from the specified methodologies for calculating the base rate and the MCLR to either inflate the base rate or prevent the base rate from falling in line with the cost of funds. These ad hoc adjustments included (i) inappropriate calculation of the funds; (ii) no change in the base rate even as the cost of deposits declined significantly; (iii) sharp increase in the return on net worth out of tune with past track record or prospects to offset the impact of reduction in the cost of deposits on the lending rate; and (iv) inclusion of new components in the base rate formula to adjust the rate to a desired level.” This simply means that rates were kept artificially high by adopting unfair means, denying legitimate savings to borrowers.

 

“Variations in the spreads across banks appear too large to be explained based on bank-level business strategy and borrower-level credit risk…spreads charged by some banks seem excessively and consistently large. The analysis suggests that banks spreads arbitrarily changed the spreads for borrowers of a similar quality. While the spread over the MCLR was expected to play only a small role in determining the lending rates by banks, it turned out to be the key element in deciding the overall lending rates. This has made the entire process of setting lending interest rates by banks opaque.” This is a malpractice, pure and simple, which an internal benchmark will perpetuate.

 

Discrimination against customers

 

In a grossly discriminatory action, new customers are offered loans at a rate lower than existing (old) customers of similar loans. With an external floater, banks cannot differentiate between a new customer and an old customer, or between the person who has approached the bank to reduce his interest burden and the one who has not. If the rate decreased, it would have gone down for everybody.

 

Also, each bank, arbitrarily and capriciously, charges borrowers for the favour of reducing the rate. It is clear that a charge to simply reduce interest on a floating rate loan is extortion, but this is exactly what the RBI has officially sanctioned. Under an earlier circular, issued in 2010, banks could not charge customers for changing the rate. In April 2016, the RBI dropped this clause, allowing each bank to charge based on mutual negotiation — where the customer had no bargaining power. If, for no other reason, external benchmarks are critical to improve the much-desired transparency and fairness of the system, since certainly banks won’t do it on their own.

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The writer is the editor of www.moneylife.in

Twitter: @Moneylifers