RBI makes it mandatory for Retail/SME loans to be priced on external benchmarks

In a late evening notification yesterday, RBI has asked banks to benchmark new floating rate personal loans and SME loans to external benchmarks from 1 October 2019.  The decision stems from unsatisfactory transmission seen by banks.  It is to be noted that RBI has cut repo rate by 110 bps since Feb-2019 while the transmission has been mere 20-30 bps across banks. Banks had resisted this as their deposits tend to reprice at a slower pace, which affects their ability to transmit.
Banks can now use either of the following to benchmark : 
(a) Repo Rate
(b) 3m Treasury bill (T-bill) 
(c) 6m T-bill
(d) or any other benchmark published by Financial Benchmarks India Private Ltd (FBIL).
Banks may prefer option (a) as it is least volatile and can also be used to benchmark deposit rates. 
Banks can also determine their spreads, but they cannot change spread unless there is material deterioration in borrower’s risk profile and should not change benchmarks once set for a borrower.
Risks to the banks may arise due to the following:
(a) a sharp cut in Repo Rate in future MPC meetings - market consensus is to cut by another 50-75 bps by FY20-end.
(b) conversion of loans from old (MCLR) to new benchmarks - this may increase the margin volatility as every 5 bps rate cut will impact 20 bps profitability of banks.
(c) a slower fall in funding costs. for example : SBI has already cut deposit rates by 50 bps to 3%, it will find difficult to cut rates even further.
If you have an existing loan, get in touch with your banker so that effective 1 Oct, your rates can accordingly be adjusted. This will require minor administrative charges to change the loan to a floating benchmark. Please note that in the case of rate hike, the rates applicable will also rise though as per RBI's MPC guidance on interest rates, this will be some time away.
This notice is NOT applicable to Housing finance companies (HFCs). Their ability to manage spreads needs to be watched as housing forms nearly 70% of loans. Compression in spreads will impact them most as competition forces may require them to match the product. They may manage pressure through some increase in corporate lending or use of derivatives such as swaps. 

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