RBI’s repo rate pauses

  • April 7, 2023
  • Posted by: OptimizeIAS Team
  • Category: DPN Topics
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RBI’s repo rate pauses

Subject : Economy

Section: Monetary policy

Concept :

  • The RBI has raised the repo rate by 250 basis points (bps) since May 2022, thereby increasing the external benchmark-based lending rate (EBLR), by 250 bps. The hike in Repo Rate was in a bid to rein in inflation.
  • Banks have also raised the lending rate linked to the marginal cost of funds-based lending rate (MCLR) in the past 11 months.
  • The focus was on withdrawing liquidity through a tight money policy to combat inflation.

The recent decision

  • The decision to keep the repo rate unchanged was taken unanimously by the Monetary Policy Committee (MPC).
  • The MPC’s decision to pause will give relief to borrowers as the external benchmark-based lending rate (EBLR), which is linked to the repo rate, will not increase.

External Benchmark Lending Rate (EBLR)

  • After the introduction of MCLR, RBI was skeptical about the implementation of MCLR by banks. Hence, RBI set up a committee which is known as Janak Raj Committee.
  • Shifting of loans from BRR to MCLR was not done by all Banks. There are certain loans which are still under BRR regime and banks are enjoying the higher profit.
  • MCLR rate used to be recalculated frequently. However, many banks used to revise MCLR only either once in 6 months or 12 months.
  • Assumed that RBI reduced its rate on Jan 2019 and banks following the revision of MCLR on a yearly basis, then Banks may revise their MCLR in December 2019. The reduction in MCLR in Jan 2019 will not be going to affect to the borrower immediately. Hence, there is a big lagging in policy implementation effectively.
  • The Committee recommended shifting to external benchmark lending rate rather than banks internally decide their benchmark.
  • This is where the RBI acted now and introduced all loans be under external benchmark lending rate effective from 1st October 2019.

How does the new system work?

  • The new system came into effect from April 1, 2019.
  • Banks will then have to link their lending rates charged on different categories of loans with an external benchmark instead of MCLR.
  • The RBI has given the following options to banks:
    • RBI repo rate
    • the 91-day T-bill yield
    • the 182-day T-bill yield
    • any other benchmark market interest rate produced by the Financial Benchmarks India Pvt. Ltd
  • One of these benchmarks will be used to decide the lending rate in addition to the spread.
  • Banks will be free to decide their spread value but it will have to be fixed for the tenure of the loan.
  • However, it can change if the credit score of the borrower changes.
  • The interest rates under the new system will change every month.

How will it benefit borrowers?

  • It will help better transmission of policy rate cuts e. an RBI rate cut will immediately reach the borrower.
  • It will make the system more transparent since every borrower will know the fixed interest rate and the spread value decided by the bank.
  • It will help borrowers compare loans in a better way from different banks.
  • Under the new system, a bank is required to adopt a uniform external benchmark within a loan category.
  • This will ensure transparency, standardisation and ease of understanding for the borrowers.
  • This would mean that same bank cannot adopt multiple benchmarks within a loan category.
  • Unlike earlier benchmarks – Base Rate and Marginal Cost of funds-based Lending Rate (MCLR) – External Benchmark-linked Lending Rate (EBLR) ensures better transmission of policy rate changes.
  • In case of a repo rate cut, banks have to pass on the entire benefit to borrowers. Likewise, borrowers will have to bear the entire burden of any repo rate hike. RBI’s Monetary Policy Report points to a more effective transmission of policy action under the EBLR regime.
  • Personal loans and other retail loans, as well as loans to small businesses, have floating interest rates based on EBLR. Banks can opt to provide such loans linked to the EBLR to other categories of loans too.
  • Banks have to follow the same external benchmark for a particular loan category. This has been done so that the borrowers can get transparent, standardised, and easy-to-understand loan products.

Significance

  • The EBLR rate benefits the borrowers and the lending banks in several ways.
  • Banks get the freedom to decide the spread over the EBLR.
  • Since EBLR is an external rate, a policy rate cut activity regarding the lending rates will reach the loan seekers sooner.
  • The interest rate process is more transparent and easier to understand for borrowers.
  • Borrowers can analyse the interest rates charged by various banks. This way borrowers know the profit margin of every bank over the fixed rate of interest, which helps compare various loan options.

economy RBI’s repo rate pauses