Several Founders, Co-Founders, CXO Bankers, CXO Fintech professional & people who participated in the ePanel discussions:
- Mr. Neeraj Chandra, Head of Operations & Technology, Abu Dhabi Commercial Bank
- Mr. Shivaraman Subramaniam, Regional Head Transaction Banking, Standard Chartered Bank
- Mr. Arvind Narayanan, Co-Founder, Enlearning skill development Pvt ltd
- Mr. Varadharajan CK, Vice President- Compliance, Equitas Small Finance Bank
- Mr. Narayan Rao, Chief Services Officer, Suryoday Small Finance Bank
- Mr. Abhishek Mody, Associate Director-Payment & Digital Initiatives, IDFC Bank
- Mr. Anand V, Vice President & Product Head- NRI Business, Kotak Mahindra Bank
- Mr. Sridhar R, former President & Credit Risk Officer, Lakshmi Vilas Bank
- Mr. P B Prakash, Head Financial Institutions Group, Indusind Bank
- Mr. Vikas R Panditrao, Co-Founder, Forum of Industry and Academic Knowledge Sharing (FIAKS)
- Many other CEO/CXO Bankers & Fintech professionals on FIAKS Forum requested to remain anonymous
On 4th September 2019 RBI issued Circulars
Circular 1: RBI Makes External Benchmark Based Interest Rate mandatory for certain categories of loans from October 1, 2019 RBI Circular Dated 4th Sept 2019
Circular 2: External Benchmark Based Lending RBI CircularDBR.DIR.BC.No.14/13.03.00/2019-20
Our community members have raised their concerns towards this matter, they say that this mandate will further kill the banks unless the deposits are also benchmarked similarly. Before we go any further let us first understand a few terminologies properly.
Floating Interest Rate: It is the interest rate of any type of debt instruments like loans, mortgage, etc. that are not fixed in nature, the interest rates keep fluctuating.
Marginal Cost of Funds based Lending Rate (MCLR): MCLR is an Internal Benchmark rate decided by the bank based on certain parameters defined by RBI. Banks cannot lend below this rate
External Benchmark Rate: It is known as a reference rate and banks cannot lend below that rate. The reference rate includes RBI policy repo rate, Government of India 3-Months Treasury Bill yield published by the Financial Benchmarks India Private Ltd (FBIL), Government of India 6-Months Treasury Bill yield published by the FBIL, Any other benchmark market interest rate published by the FBIL.
Bank Spread Rate: Spread rate is the margin that banks earn over the benchmark rate (in case of loans) and for deposits, the rate offered is Benchmark rate minus the spread.
Our community members have raised their concerns towards this matter, they say that this mandate will further kill the banks unless the deposits are also benchmarked similarly. If deposits are benchmarked externally it will involve a lot of education and understanding of the working to the depositor. There could possibly be two types of deposits-
- One benchmarked externally on deposit date but the rate does not fluctuate during the duration of the deposit. If the benchmark rate goes down the bank suffers and the customer benefits and vice versa but if the rate goes up consumers may be tempted to cancel their deposits and rebook them and under the existing regulations there cannot be a penalty on such an act either. Penalty can be charged by Banks in case rate is fixed.
- Two benchmarked externally but the rate gets reset every quarter. This will have to be demonstrated like a LIC policy with potential return scenarios. This will be very difficult to sell to the consumer.
On the other hand, banks may also stop offering floating rate loans if they cannot manage the mismatch. Both sides of the Balance Sheet have to be benchmarked similarly, offering deposits in fixed-rate & loans in floating rate is not a problem. Banks run such mismatches in their balance sheet, what we need is a deep & well-developed swap market as well as the ability to manage the MTM swings. So we will shortly see benchmarked deposits marketed extensively at least to corporate depositors and banks are definitely going to see some challenges on the transition although it is not sure about how many of the private banks will really pass on the benefits to the borrowers. Firstly, the circular permits the banks to adopt a uniform external benchmark within a loan category thereby limiting manipulation and Secondly, this is limited to all new floating rate personal or retail loans (housing, auto, etc.) and floating rate loans to Micro and Small Enterprises, which currently accounts for less than 25% of all formal credit. The components of spread including operating cost are frozen for three years. Instead of the existing practice where operating cost is imbibed in the MCLR and is reviewed as and when there is a reset which could be quarterly, half-yearly or annually which means that cost escalation cannot be passed on to customer, from the bank’s point of view the escalation in cost could not be passed for 3 years. The deposit rates may undergo frequent changes. During the discussion with RBI, the major showstopper was the operating cost and the manner of dealing with it since costs keep on rising and how this could be handled and how frequently can we change the spread during reset, the RBI said that they would review this aspect and provide clarity. Banks might now think of adding future operating cost escalation into the spread and may get internal board approval since the RBI has given powers to the banks for deciding the spread. Once the spread is set, it cannot be changed unless and only when borrower’s credit assessment undergoes a substantial change and it is also surely said that banks will build that in as a part of their spread at the initial stage itself. Our members say that when they discussed these issues with the RBI officials they expressed that Indian money market does not consider operating costs and other components and may result in extending credit especially like small finance banks which are new and whose operating costs are high. What is also another interpretation by one of our members is that only credit risk premium can be altered when the credit profile deteriorates. The other components can be reviewed once in 3 years. Although that may seem true but isn’t it also true that three years is a long gap, for most of the loans other than home loans, the tenor will not be long enough to have that many changes to spreads.
Does bank spread also include the processing fees/etc other components? As we know that spread is the margin that banks earn. Spread does not include processing fees. It is just the base rate plus risk premium and operating cost. Therefore there’s room for banks to then add the double treat for themselves using processing fees/convenience charges, but there needs to be some relief for long term loans.
Ms. Anuradha Panditrao, Founder of Forum of Industry & Academic Knowledge Sharing (FIAKS) acknowledges and thanks to the FIAKS Community members for their valuable contributions in creating an intellectual pull by participating in the discussions.
Bibliography
RBI Circulars dated 4th Sept 2019
[1] PR618AAD8BEB288124F9C937B25CBBC172DDB (2) 20190904201407