Monetary transmission improving in retail and SME segments, says RBI

There are early indications of an improvement in transmission to bank loans sanctioned in the retail and small and medium enterprises (SME) segments, where new floating rate loans have been linked to external benchmarks, the Reserve Bank of India (RBI) said in a report put out on Wednesday.
The report, published as part of the central bank’s monthly bulletin for March 2020, states that the weighted average lending rates (WALRs) charged by domestic banks on fresh rupee loans sanctioned for the housing sectors declined by 38 basis points (bps) and that on vehicle loans by 47 bps between October 2019 and January 2020. The WALR of domestic banks in respect of loans to micro, small and medium enterprises (MSMEs) also dropped 59 bps in January. However, the WALR in education loans increased marginally by 1 bp in January.

“The external benchmark framework will quicken transmission to lending rates (i) as any change in the benchmark rate will lead to a change in lending rates for new borrowers; (ii) for existing borrowers, banks would need to reset interest rates at least once in three months as against typically one year in the case of loans linked to the MCLR (marginal cost of funds based lending rate); and (iii) by constraining banks from adjusting their spreads arbitrarily for existing borrowers,” RBI said.

The report explained that under the MCLR system, transmission to lending rates is indirect and contingent upon changes in deposit interest rates. However, under the external benchmark system, transmission to lending rates will no longer be contingent upon deposit interest rates. As and when the monetary policy committee changes the policy repo rate, lending interest rates will change, at the most within a quarter.

“Banks will then need to adjust their deposit rates to protect their NIMs (net interest margins),” the report said. Among the reasons for poor transmission of rate reductions through lending and deposit rates, the central bank mentioned that the long maturity profile of deposits at fixed interest rates, rigidity in savings rates, the legacy of base rate  loans, the periodicity of interest rate reset under the MCLR system, competitive  pressure from mutual funds and small savings schemes as well as poor asset
quality of banks.

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