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RBI group's views on loan rates not practical enough, say bankers

Lending rates should factor in that credit costs vary with loans and banks, they argue.

, ET Bureau|
Updated: Oct 06, 2017, 08.20 AM IST
High sensitivity to liquidity conditions, credit cycles and seasonality also limit the effectiveness of CD rates.
High sensitivity to liquidity conditions, credit cycles and seasonality also limit the effectiveness of CD rates.
Mumbai: The Reserve Bank of India (RBI) appointed internal study group's suggestion to use either treasury bills, certificate of deposits (CDs) or the repo rate as an external benchmark for bank lending rates is not practical enough to implement due to issues around liquidity , rate calculation and because cost of funds for banks vary , bankers said.

The report of the Internal Study Group formed by the RBI to review the marginal cost of funds-based lending rate system (MCLR) has suggested that these three rates are best placed to serve as an external benchmark because of their correlation with the policy rate, stability and liquidity.

Bankers, however, said bank lending rates should also take into account the credit costs on different loans so that banks can make fair margins and the benchmark rate should be uniform enough so that all lenders can adopt them.

“The benchmark should include both assets and liabilities, it cannot be one sided. Bank margins need to be sufficient to take care of the credit costs. Both the pricing of loans and of liabilities have to be taken into account. We cannot say that reduce interest rates but leave deposit rates unchanged. We are all for transparency but it should also take care of margins,“ said Rajnish Kumar, chairman-designate of State Bank of India (SBI).

Kumar cited the example of how credit costs for loans to some sectors are high due to the inherent risks in those sectors but home loans, for example, have lower rates because credit costs and capital requirements for banks are lower.

The study group headed by Janak Raj, principal adviser at RBI's monetary policy department, described T-bills and CD rates as ones with a reliable market deter mined rate curve.However, the report has also pointed out that both these markets are not deep enough, which makes them susceptible to manipulation.

High sensitivity to liquidity conditions, credit cycles and seasonality also limit the effectiveness of CD rates. The RBI's benchmark repo rate is robust, reliable, transparent and easy to understand. But being the benchmark monetary policy rate, it can constrain future changes in the monetary policy framework, the study group said.

Bankers say that none of the benchmark rates are perfect and it will need some fine tuning. “For example, if we use the CD rates, how can there be uniformity because smaller banks have higher rates. Similarly, T-bills' market liquidity is coming down as the government is moving towards longer term bonds. And how will you benchmark long-term lending with the repo rate on a fully hedged basis. So, all banks will have to come up with some workable solutions,“ said Arun Khurana, head of treasury at IndusInd Bank.
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