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.
