No Transmission of Rate Cut, Borrowers Can Get Fleeced but RBI Junks External Benchmark Idea
With every rate cut, the media tell you that your home loans and other loans have become cheaper. This, alert borrowers is, a lie. Banks do not reduce the rates in tune with policy rates. And this lie will continue, thanks to Reserve Bank of India’s (RBI's) policy of junking the implementation of external benchmark.
Between February and June 2019, RBI has reduced policy rates by 75 basis points (bps). According to RBI financial markets have fully transmitted the changes in policy rates. The weighted average call money rate (WACR) fell by 78bps, market repo rate by 73bps and 10-year benchmark G-Sec yield by 102bps. But banks, on the other hand, have reduced their interest rates on fresh rupee loans only by 29bps during February-June 2019.
And yet, the RBI governor, Shaktikanta Das, has decided to junk the linking of floating interest rates for retail loans to external benchmark. The central bank now wants to consult stakeholders and review liking of floating interest rates with external benchmark.
This is a major change in stance by RBI which, in April this year, had succumbed to pressure from banks and delayed indefinitely the plan, committed by former RBI governor Dr Urjit Patel.
In December 2018, the central bank, then headed by Dr Patel had asked all banks to adopt new external benchmark for providing loans for home, auto and micro and small enterprises (MSME) from 1 April 2019.
Speaking to reporters after the monetary policy review, governor Das said that RBI is again having stakeholder consultation on linking floating interest rates for retail loans to external benchmark and is reviewing it. “We do recognise that the banks are coming out of their problem of non-performing assets (NPA). Deposit growth has been slow. So, administratively, we did not want to mandate it at that particular time, but as I mentioned little earlier, we are monitoring the situation and RBI will take whatever steps are required to ensure better transmission. It is better to allow the market forces to play. Wherever regulatory interventions are required, the RBI will take necessary regulatory measures,” he said.
Responding to a question if the intervention from RBI would be off the table, Mr Das says, "I did not say that it is off the table or on the table. I only had stated earlier that on the external benchmark, we are again having stakeholder consultation and we have put it into review. So, all options are available to the Reserve Bank. So, we will take a considered call as and when the situation warrants."
“Our interactions with various stakeholders, including both public sector and private sector banks, indicate that steps are being taken by them on an ongoing basis to progressively lower their interest rates so that the benefits of the policy rate reductions are passed on to the economy. Accordingly, we expect higher transmission of monetary policy actions and stance by the banks in the weeks and months ahead,” Mr Das says.
Before the RBI decision of last December, Moneylife Foundation had filed a public interest litigation (PIL) in the Supreme Court (SC) praying for an external benchmark, among other things. The SC had asked RBI to respond to Moneylife Foundation. Instead of a specific response, RBI had gone ahead and announced the external benchmark.
RBI's decision in December 2018 was based on recommendation by Dr Janak Raj Committee. The Committee in its 2017 report "Internal Study Group to Review the Working of the MCLR System" had provided a shocking account of how wide and deep banking malpractices are with regard to floating rate loans. It confirmed every one of our arguments about how banks cheat customers, fudge rates and extort conversion charges.
Dr Patel resigned on 10th December and Mr Das took over as new governor of RBI on 12 December 2018. In April this year, Mr Das, who is a former revenue secretary, decided to keep the issue of linking interest rates to external benchmark on the back-burner, much to the surprise and dismay of borrowers, who have been shortchanged by the banks.
Mr Das, in his first monetary policy decision in February 2019, called Dr Patel’s directions as ‘draft guidelines’. In the April monetary policy statement, Mr Das stated that RBI would hold further consultations with stakeholders and work out an effective mechanism for transmission of rates.
According to a report from Times of India,
banks were understood to have opposed an external benchmark proposal as often the repo rate or the treasury bill rate were not indicative of their cost of funds.
Quoting Sunil Mehta, managing director (MD) and chief executive (CEO) of Punjab National Bank and chairman of Indian Banks' Association (IBA), the report says, "The IBA had represented the apprehension of the banking sector on moving towards the external benchmarks. The RBI has indicated further discussions with the stakeholders before introducing an external benchmark."
While the IBA has been expressing its apprehension on adopting new external benchmark with interest rates, State Bank of India (SBI), the country's largest lender, had already taken a decision on this. From 1 May 2019, SBI has decided to link interest rates with repo rate for saving bank deposits of over Rs1 lakh and short-term loans.
Interestingly, while IBA continues to oppose external benchmark for retail loans, Financial Benchmarks India Pvt Ltd (FBIL), in which the Association holds 10% stake, develops and administers benchmarks relating to the money market, government securities, and foreign exchange in the country. Fixed Income Money Market & Derivatives Association of India and Foreign Exchange Dealers’ Association of India hold 76% and 14% stake in FBIL.
Regular readers would know Moneylife Foundation has been relentlessly campaigning against arbitrary and opaque bank policies with respect to floating rate loans. Borrowers, who have taken loans on a floating rate basis, suffer an immediate increase when interest rates are hiked by RBI but do not get much relief when rates go down. This makes a mockery of the very concept of ‘floating’ rates.
We have highlighted this issue in several articles and our Cover Story “Banksters
, 28 April-11 May 2017).
The external benchmark suggested by RBI in December included its policy repo rate, government of India 91 days treasury bill yield produced by the Financial Benchmarks India Pvt Ltd (FBIL), government of India 182 days treasury bill yield produced by the FBIL, or any other benchmark market interest rate produced by the FBIL.
RBI, then headed by Dr Patel, had said, "The spread over the benchmark rate—to be decided wholly at banks’ discretion at the inception of the loan—should remain unchanged through the life of the loan, unless the borrower’s credit assessment undergoes a substantial change and as agreed upon in the loan contract."
This, in other words, means that, with the spread remaining fixed, banks will have to adjust interest rates as per the changes in external benchmark.
The RBI study had highlighted how banks deviated in an ad hoc manner from the specified methodologies for calculating the base rate and the MCLR, to either inflate the base rate or prevent the base rate from falling in line with the cost of funds.
It says, “Banks have been quite slow in migrating their existing customers to the MCLR regime. Most of the base rate customers are retail or small and medium enterprise (SME) borrowers. Hence, the banking sector’s weak pass-through to the base rate is turning out to be deleterious to the retail and SME borrowers in an easy monetary cycle.”
"The ad hoc adjustments used by banks, included inappropriate calculation of the cost of funds; no change in the base rate even as the cost of deposits declined significantly; sharp increase in the return on net worth out of tune with past track record or future prospects to offset the impact of reduction in the cost of deposits on the lending rate; and inclusion of new components in the base rate formula to adjust the rate to a desired level. The slow transmission to the base rate loan portfolio was further accentuated by the long (annual) reset periods," the report had said.
Noticing this grave injustice, Moneylife Foundation wrote to Dr Patel, the then governor of RBI, requesting to direct banks to calculate the excess interest they have charged (through arbitrary and ad hoc
calculations of base rate or MCLR) and refund the money to borrowers, especially retail borrowers and SMEs. (See Excess Interest Charged by Banks under Base Rate and MCLR Regime
“The RBI should also direct banks to set up special helplines to handle complaints from borrowers, whom banks have overcharged over the years. We also request the Reserve Bank to immediately issue circular/master directions asking banks and financial institutions to allow existing borrowers to migrate to MCLR or any new system without any conversion fee or any other charges for the switchover,” the memorandum had said.
RBI refused to act on it. We then had to file a PIL in the Supreme Court.
The PIL filed by Moneylife Foundation sought justice for a huge section of Indian population including the middle class and lower middle class, who are badly affected by such discrimination. The primary respondent was the RBI. Others named were: ministry of consumer affairs, ministry of finance, Indian Banks’ Association (IBA), National Housing Bank (NHB), Banking Code and Standards Bank of India (BCSBI).
The petition prayed that,
Banking companies and non-banking finance companies (NBFCs) should calculate the amount of excess interest that has been charged to the existing borrowers under floating rate regime by denying the benefit of lower rates to pass through the benefit of a reduction in the interest rates to the existing consumers and borrowers of home loans, education loans and loans provided for consumer durables.
The amounts calculated above be transmitted to a central corpus under the aegis of the RBI and refund of such overcharged amount be directed to the borrowers by crediting the accounts through a centralised scheme to be framed by the RBI to pass through the benefit of a reduction in the interest rates to the consumer and borrowers of home loans, education loans and loans for durables.
Banking companies and NBFCs be directed that insofar as floating rate loans are concerned there can be no conversion charge extracted from customers who are entitled to avail the lower rate.
Banks and NBFCs, with effect from 1 April 2016, should apply to all customers who have availed floating rate loans, the rates computed based on the Master Directions (Interest Rates on Advances), 2016 irrespective of their acceptance;
The periodicity of reset under the MCLR system be conducted quarterly.
Borrowers be intimated of the change in repo rates and the corresponding reset within a day of such change by at least three modes of communications via multiple channels such as email, text messages and over telephone; and, banking companies and NBFCs should publish the methodology of setting the rate of interest and particulars of the spread on their website on a weekly basis.
The Supreme Court, on 8 October 2018 directed RBI to respond within six weeks to representations made by Moneylife Foundation on the unfair practice of banks regarding floating loans.
The bench of Chief Justice Ranjan Gogoi, Justice SK Kaul and Justice KM Joseph
, said, "Having heard the learned counsel for the petitioners and having considered the matter, we are of the view that, at this stage, the RBI should be directed to communicate its decision in the matter covered by the representation or letter of the petitioner dated 12 October 2017 to the petitioner within a period of six weeks from today. Thereafter the petitioners, if still aggrieved, will be at liberty to approach this Court once again."
We still have not received any positive response from RBI on our memorandums or the directions from the apex court.
Looking at these development, Moneylife Foundation will again have to approach the Supreme Court to seek justice for millions of retail loan borrowers and small enterprises. Meanwhile, RBI has, once again, showed that it is less interested in fairplay for consumers and more in protecting the interests of banks.