InvestorQ : Will the banks shifting to external benchmarking for loans benefit the borrowers?
swati Bakhda made post

Will the banks shifting to external benchmarking for loans benefit the borrowers?

Dia Deshpande answered.
2 years ago

During the week, the RBI announced that all banks will shift to pricing their loans based on an external benchmark like the RBI repo rates or the RBI MSF rate so that any rate cuts can be seamlessly passed on. This shift will be effective from October 01st and will apply to all loans extended to retail customers as well as to small and medium enterprises (SMEs). Effectively, all home loans that are of a floating rate nature will now be linked to these external benchmarks and the rates will be adjusted accordingly. What does this mean and will it benefit the borrowers?

In the past, the average cost of funds formula and the marginal cost of funds have had limitations. That is where external benchmarking comes into the picture. It is in this light that the government and the RBI have decided to shift to external benchmark based pricing for retail and SME loans. The external benchmark will be applicable for floating rate loans and not to fixed rate loans. The benchmark can be either the repo rate or some other external rate that is independent of the cost of funds of the bank.

Will this work? Most bankers are still quite sceptical whether such benchmarking would really work in practice. There are 3 reasons for this view. Firstly, banks feel that any pricing without reference to costs can never work. It will end up giving sub optimal loans to customers and result in losses to banks. Secondly, banks also feel that customers themselves will not be comfortable with loans that are just too vulnerable to constant shifts in the EMI or tenure, whatever is adjusted. Lastly, banks feel that to achieve external benchmarking, deposit rates must be very flexible but that would not work at a time when the market for CASA deposits is so competitive.