External Benchmarks Lending Rate

  • IASbaba
  • July 21, 2021
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External Benchmarks Lending Rate

Part of: GS Prelims and GS – III- Economy

In News: In a recent RBI report on ‘Monetary transmission in India’, the share of outstanding loans linked to External Benchmarks Lending Rate (EBLR – like repo rate), increased from as low as 2.4% during September 2019 to 28.5% during March 2021.

About Internal Benchmark Lending rate (IBLR)

  • Lenders usually have an internal rate, which is the benchmark rate. Interest rates on all loans are linked to it.
  • For example, a lender’s benchmark rate is 6%.
    • It would offer an auto loan 2% higher than the benchmark rate, which will be 8%. 
    • Similarly, it may provide personal loans at 8% higher than the benchmark rate or at 14%.
  • Initially, RBI focused on making the benchmark rate transparent. It introduced different ways to calculate the benchmark rates which are as follows
Benchmark Prime Lending Rate (BPLR)
  • It was used as a benchmark rate by banks for lending till June 2010.
  • Under it, bank loans were priced on the actual cost of funds.
Base Rate
  • Loans taken between June 2010 and April 2016 from banks were on base rate.
  • Base rate was the minimum interest rate at which commercial banks could lend to customers.
  • Base rate is calculated on three parameters — the cost of funds, unallocated cost of resources and return on net worth.
  • Hence, the rate depended on individual banks and they changed it whenever the parameters changed.
Marginal Cost of Lending Rate (MCLR): 
  • It came into effect in April 2016.
  • It is a benchmark lending rate for floating-rate loans. 
  • This is the minimum interest rate at which commercial banks can lend.
  • This rate is based on four components—the marginal cost of funds, negative carry on account of cash reserve ratio, operating costs and tenor premium.
  • MCLR is linked to the actual deposit rates. Hence, when deposit rates rise, MCLR  rises and lending rates increases.

What were the issues related to Internal Benchmark Lending Rates?

  • The problem with the IBLR regime was that when RBI cut the repo and reverse repo rates, banks did not pass the full benefits to borrowers.
    • Repo rate is the rate at which the RBI lends money to the banks for a short term. Here, the central bank purchases security.
  • In the IBLR Linked Loans, the interest rate has many internal variables of Bank which prevented the smooth transmission of RBI’s Monetary Policy changes.

About External Benchmark Lending Rate (EBLR)

  • RBI mandated the banks to adopt a uniform external benchmark within a loan category, effective 1st October, 2019.
  •  4 external benchmarking mechanisms: 
    • The RBI repo rate
    • The 91-day T-bill yield
    • The 182-day T-bill yield
    • Anny other benchmark market interest rate as developed by the Financial Benchmarks India Pvt. Ltd.
  • Banks are free to decide the spread over the external benchmark. However, the interest rate must be reset as per the external benchmark at least once every three months.
  • Significance: Faster Monetary Transmission + Transparency in Interest rates + Standardisation of fixing interest rate.

Concerns

  • 28.5% of outstanding loans were linked to EBLR during March 2021.
  • However, still 71.5% of outstanding loans are Internal Benchmark Lending Rate (IBLR- like base rate and MCLR) linked loans, which continues to impede the monetary policy transmission.
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