Reserve Bank's policy repo rate are better suited than other interest rates to serve role of an external benchmark.
Mumbai: For effective transmission of policy rate to borrowers, an RBI study group today suggested banks should switchover to a new interest rate calculation regime from the existing MCLR system.
The Study Group recommended the T-Bill rate, the certificates of deposit (CD) rate and the Reserve Bank's policy repo rate are better suited than other interest rates to serve the role of an external benchmark.
"The T-bill rates are risk free and also transparent. They also have a reliable term money market curve. CD rates relate to the credit market directly in the sense that banks could meet their marginal requirement of funds from this market. CDs also have a reliable term money market curve," the report said.
Noting that the RBI's policy repo rate has the primary advantage that it is robust, reliable, transparent and easy to understand, the report said, it reflects the appropriate rate for the economy at any point in time based on the MPCs assessment of macroeconomic conditions and the outlook. With the repo rate as the benchmark, the transmission of the repo rate changes to lending rates of banks will be quick, direct and strong, it said.
"The repo rate as a benchmark, however, can constrain future changes in the monetary policy framework. Banks also have limited access to funds at the repo rate. Being an overnight rate, the repo rate also lacks a term structure," it said.
The study group set up by the RBI to Review the working of the Marginal Cost of Funds Based Lending Rate (MCLR) system has also said that banks should allow existing borrowers to migrate to MCLR system without any conversion fee.
The panel has also recommended that the periodicity of resetting the interest rates by banks on all floating rate loans, retail as well as corporate, be reduced from once in a year to once in a quarter.
The RBI noted that the lower transmission from the policy rate to the base rate loan portfolio was mainly due to the reason that banks followed different methods to calculate the base rate.
"Banks, therefore, could be advised to re-calculate the base rate immediately by removing/readjusting arbitrary and entirely discretionary components added to the formula," the report said.
The report recommended adoption of external benchmark from April 1, 2018. RBI introduced MCLR on April 1, 2016 after finding that the then prevailing base rate had failed to achieve the objectives of easier and faster policy transmission.
Before the MCLR was rolled out, the banks were following a more rigid base rate system, which came into force on July 1, 2010 replacing the banks' prime lending rate. The study group submitted its report on September 25.
"Arbitrariness in calculating the base rate/MCLR and spreads charged over them has undermined the integrity of the interest rate setting process," the study group has observed.
The base rate/MCLR regime is also not in sync with global practices on pricing of bank loans, it said, adding that "the study group has, therefore, recommended a switchover to an external benchmark in a time-bound manner".
Addressing the media earlier in the day, RBI Deputy Governor Viral Acharya said the report has proposed three possible external benchmarks to which such lending could be tied to going forward.
"We think the internal benchmarks such as the base rate and MCLR, based on data, seem to give banks very high amount of discretion, lots of factors that are flexible to them to ensure that the lending rate can be kept high even if monetary policy is going down and accommodative," he said.
He also said the move is to address the above mentioned lacunae by bringing in a better global benchmark wherein these rates are tied to external benchmarks as "this will create a fair bit of transparency for borrowers and they can just compare two loans and see which is at the lower spread because the benchmark will be the same".