About: Interest rate transmission 

About: Interest rate transmission 

  • The monetary policy of the country is handled by RBI, under which it takes various steps to manage inflation and money supply in the economy.
  • Repo rate is the rate at which RBI lends funds to banks and Reverse repo rate is the rate at which it borrows funds from banks.
  • RBI increases or decreases these rates to control the flow of money in the economy.
  • Based on their cost of borrowing, the banks can change the rates at which they lend to their borrowers. This is called the transmission of interest rate in the economy.

UPSC Mains Questions and Answers

In Focus: Internal benchmark lending rate

  • Earlier, banks used to follow the internal benchmark based lending rate for lending.
  • Under it, different mechanisms like the BPLR, Base rate and MCLR, were followed to calculate the reference rates for lending.

BPLR:

  • Benchmark prime lending rate (BPLR) was used as benchmark rate by banks for lending till 2010.
  • It was calculated by taking into consideration cost of funds; operational expenses; and a minimum margin to cover regulatory requirements and profit margin.
  • RBI noticed that banks kept BPLR at an artificially high level, and were misusing it by lending money at rates lower than BPLR to privileged customers. Meanwhile, other retail customers continued to get loans at a higher rate.

Base rate:

  • Later, in 2010, RBI changed the reference rate for IBLR from BPLR to Base rate.
  • Base rate was the minimum interest rate at which commercial banks could lend to customers.
  • Base rate was calculated on three parameters — cost of fund, unallocated cost of resources and return on net worth.
  • Hence, the rate depended on individual banks and they changed it whenever their cost of funds and other parameters changed.

MCLR:

  • In April 2016, RBI made marginal cost of funds based lending rate (MCLR) as the benchmark rate for lending. It was the minimum rate at which the banks could lend.
  • MCLR is based on four components—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, it indicates the banks are likely to increase MCLR and lending rates will increase.

Reasons for introducing EBLR (External Benchmark based Lending Rate)

  • Under IBLR, borrowers complained that lenders were quick to increase interest rates on loans when the RBI increased policy rates.
  • However, when the RBI would lower policy rates, lenders would decrease rates at a much slower pace for existing customers.
  • In order to fix this issue and increase transparency, RBI introduced external benchmark-based lending rates (EBLR), in October 2019.
  • Being an external system, this meant any policy rate cut decision could reach borrowers faster.

About: EBLR

  • EBLR offered banks the options to choose from 4 external benchmarking mechanisms:
    • RBI repo rate;
    • 91-day Treasury bill yield;
    • 182-day Treasury bill yield; or
    • Any other benchmark market interest rate developed by the Financial Benchmarks India Pvt. Ltd (FBIL)
      • FBIL is a private company working to develop and administer benchmarks relating to money market, government securities and foreign exchange in India.

    • The RBI had made it mandatory for banks to link all new floating rate personal or retail loans (housing, auto etc.) and floating rate loans to MSMEs to an external benchmark from October 1, 2019.
    • Banks are, however, free to extend the same rate to other loans including fixed rate loans.
    • To ensure complete transparency and standardization, banks are mandated to adopt a uniform external benchmark rate within a loan category.
    • However, the interest rate must be reset as per the external benchmark at least once every three months.
    • Existing loans and credit limits linked to the MCLR/Base Rate/BPLR had to continue till repayment or renewal, as the case may be.

About: Floating and fixed rate loans

  • floating interest rate refers to a variable interest rate that changes over the duration of the loan.
  • It is the opposite of a fixed interest rate, where the interest rate remains constant throughout the life of the loan.

About: Treasury bills 

  • Treasury billsare bonds or securities issued by the Government of India as a promissory note with guaranteed repayment at a later date.
  • Treasury bills, or T-bills, have a maximum maturity period of 364 days.
  • They are issued in various maturity categories like 91-day, 182-day and 364-day.

News Summary:

  • The Reserve Bank of India (RBI) recently released a report titled ‘Monetary transmission in India
  • The report gives details of loans under the Internal and External benchmark based lending mechanisms, with differing impact on interest rate transmission.

Highlights of the report:

  • The share of outstanding loans linked to external benchmarks like the Repo rate rose significantly in the last two years.
  • Share of outstanding loans linked to external benchmarks increased from as low as 2.4 per cent during September 2019 to 28.5 per cent during March 2021.
  • Most banks — 38 of the 58 banks which introduced external benchmark linked loans(out of a total of 71 banks that responded to a survey) — have adopted the repo rate as the external benchmark.

IBLR based loans:

  • However, the internal benchmark linked loans (BPLR, base rate and MCLR) together comprised 71.5 per cent of outstanding floating rate rupee loans as of March 2021.
  • Thus, the desired level of interest rate transmission is yet to be achieved.
  • MCLR based loans continue to be the dominant rate structure for the banking industry. The share of loans linked to MCLR stood at 62.9 per cent as of March 2021.
  • Around 6 per cent of floating rate rupee loans were still linked to the BPLR and base rate, even though the RBI had moved to MCLR based regime over five years ago.

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