India's banks to lend at benchmark rates

External benchmark-based lending must: RBI

Indian lenders, especially private, that have been reluctant to pass on the benefit of low policy rates to borrowers, will witness a contraction in their Net Interest Margins (NIMs) as borrowers migrate to the new rate regime.

Banks with a larger proportion of retail and MSME loans will be impacted the most.

Now, banks will have no choice but to link deposit rates to external benchmarks, or actively hedge their assets in the interest rate swap market.

Kotak Institutional Equities said the change would cast a shadow on bank margins as MCLR rates are now higher than repo-linked instruments.

The facility will be available to new borrowers, while existing customers can switch to a repo-linked rate on "mutually accepted" terms with their bankers.

Frequent revision in the benchmark rate will also lead to subsequent changes in equated monthly instalments (EMIs) or tenure of the loan as the RBI has directed banks to reset interest rates at least once in a quarter.

"For several banks most of their funds are in public deposit where the rates can not be reduced overnight or else the banks will suffer adversely on net interest margin".

Only about a fourth of deposits fall in the less than one-year bucket, as indicated by the aggregate number put out by RBI (individual bank numbers may vary). In the current scenario, the spread between repo and the actual rate is 460 basis points. Hence, to protect margins, the bank would have to create a buffer and widen the spread to maybe 480 bps or even 500 bps. The fall may be just 20 bps or 10 bps, depending on the strength of the bank's deposits franchise.

Given that interest rates are headed down, lower cost of borrowing is expected to inspire small borrowers to avail bank loans.

Under the revised rates, effective 1 September, the bank's one-year MCLR will come down to 8.55 percent, while the overnight MCLR will be 8.30 percent. The historic low for the repo rate is 4.75% which is 65 bps lower than the current rate of 5.4%.

Under the new norm, banks have been allowed to choose among the repo rate, the government's three-month and six-month treasury bill yield published by the Financial Benchmarks India Pvt. But to ease depositors' pain, the bank had retained the earlier 3 per cent rate on such deposits.

While the new framework was introduced a year ago, it was not compulsory for banks to adopt it.

"The final rate charged to this category of borrowers, after switchover to external benchmark, shall be same as the rate charged for a new loan of the same category, type, tenor and amount, at the time of origination of the loan", the RBI said. Also, the RBI has laid down a minimum three-month reset period for interest rate on loans.

"What happens if a bank links the rates to, say, three-month or sixmonth treasury bill and there is sudden liquidity crisis, which leads to rates shooting up?"

One way to gauge the impact on earnings on account of holding assets and liabilities across different maturities or re-pricing dates is to look at the interest rate risk in the banking book (IRRBB), as disclosed under the Basel requirement by Indian banks.

"First, we will try to link the savings bank interest rate and then gradually we will try to introduce some term deposit products so that the transmission of the rates are equal on both sides", he said.

"Rates may come down by a few basis points (bps), but it's not that home loans, which are in the range of 8-9 per cent, will reduce to 6 per cent", said the chief financial officer of a private bank, requesting anonymity.

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