New loan pricing: Acharya says RBI studying transition cost

Deputy governor Viral Acharya has said the suggestions received on the recommendations of the RBI study group on an external benchmark-based lending rate system are being carefully examined, keeping in view the transition cost to the new loan pricing system.

Last month, the central bank had released a report by a study group that was tasked by the RBI to suggest the pros and cons of shifting to an external benchmark based lending rate system aimed at fastening the transmission of policy rates by banks.

The move came as the regulator has not been happy with the banks' reluctance to pass on the rate cuts to borrowers form quite some time now.

Currently banks price loans on the basis of their marginal cost of funds, which is in force since April 2016, replacing the base rate system that came into effect from July 2014 replacing the prime lending rate system of loan pricing.

Each of these pricing systems changes were aimed at better transmission of the policy rates and make loan pricing more transparent.

"We've received a number of suggestions and comments on the report of the study group. These are being examined factoring in transition costs and providing a calibrated path to the desired benchmarking system," Acharya said at a speech at the Tata Institute of Fundamental Research here last week.

He said efficient monetary transmission is a sine qua non (a necessary condition) for the successful pursuit of its objectives by any central bank.

Over the past two decades, it has been RBI's endeavour to strengthen the monetary transmission process, but these efforts have yet not yielded the desired results, he said.

"The transmission from the policy repo rate to bank lending rates, which is the dominant transmission channel in our country, has remained a matter of concern," he said.

The study group said internal benchmark-based pricing regimes are not in sync with global practices on pricing of bank loans and recommended that the switchover to an external benchmark needs to be pursued in a time-bound manner.

The report recommended that the treasury bill rates, the certificate of deposit rates, and the RBI policy repo rates are better suited than other interest rates to serve the role of an external benchmark.

"All floating rate loans from April 1, 2018 could be referenced to one of the three external benchmarks selected by the RBI after receiving and evaluating the feedback from stakeholders," the report said.

Acharya said there is a deeper economic issue at hand in the recommendation to move towards an external benchmark.

He further said even as the RBI has reduced its policy repo rate by 50 bps since October 2016 and a higher 200 bps since December 2014, bank credit has remained much muted.

"While weak demand for bank credit could be one of the factors leading to this slowdown, a primary cause had also been the weak balance sheets of public sector banks in view of large NPAs which seem to have made banks risk averse and induced them to reduce the supply of credit," he said, adding under-capitalised state-run banks have capital only to survive, not to grow.

The dominance of the supply side factor has also been borne out by the fact that credit growth of private sector banks remains robust, whereas there has been a sharp deceleration at public sector banks, the deputy governor said.

Acharya said the IBC, Banking Regulation (Amendment) Ordinance 2017 and the subsequent actions taken by RBI wherein it asked banks to refer the largest NPAs to IBC for resolution, etc have made the IBC a lynchpin of the new time- bound resolution framework for bank NPAs.

These initiatives will now be supported by government decision to recapitalise state-run banks in a front-loaded manner, with a total allocation of Rs 2.1 trillion, comprising budgetary provisions (Rs 18,100 crore), recapitalisation bonds (Rs 1.35 trillion), and the rest Rs 58,000 crore to be raised from the markets by diluting government stake.

"These two steps together--asset resolution and bank recapitalisation-are expected to strengthen bank balance sheets significantly and improve their ability to lend at rates in consonance with policy rates and result in an improved monetary transmission," Acharya said.

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