INSUBCONTINENT EXCLUSIVE:
Under the new rules, banks will be free to decide the spread over the external benchmark.Moody's Investor Service on Tuesday said the
RBI's mandate on aligning commercial bank floating loan rates to the external benchmark from next month is credit negative for Indian
banks."Currently, banks' floating rate loans are benchmarked to the Marginal Cost of Funds-based Lending Rates (MCLR)
With changes in lending rates aligned to changes in the cost of funding, banks are able to mitigate their interest rate risk."Under the new
rules, this direct linkage between lending rates and funding costs will no longer exist
This will expose banks to asymmetrical movements in the cost of funding and loan yields, thus exposing them to interest rate risks," the US
rating agency said in a report."On September 4, the Reserve Bank of India (RBI) mandated that all new floating rates for personal and retail
loans, along with loans to micro, small and medium enterprises (MSMEs) are to be linked to an external benchmark from October 1
This is a credit negative for India's banks as it will limit their flexibility in managing interest rate risk", it added.This new external
other benchmark market interest rate published by the Financial Benchmark India Private Ltd -- an entity that administers benchmark
rates.Under the new rules, banks will be free to decide the spread over the external benchmark.Subsequently, credit risk premiums may
undergo change when a borrower's credit assessment also undergoes a substantial change, as agreed upon in the loan contract
Moreover, other components of spreads, including operating costs, can be altered once every three years.Under the new rules, the direct
linkage between lending rates and funding costs will no longer exist
This will expose banks to asymmetrical movement's in the cost of funding and loan yields, thus exposing them to interest rate risks.These
risks will be manifest in three ways, the Moody's report said.Under the new regime, while the floating rate loan book will get re-priced,
only the non-current and savings accounts (CASA) deposits will see a re-pricing
CASA makes up a significant portion of bank deposits
Interest rates on CASA deposits tend to be tend to be low but stable.According to the report, this will bring volatility to bank's net
interest margins (NIMs), with NIMs rising when interest rates increase and declining when interest rates fall
This volatility in NIMs will translate into volatility in the overall profitability of banks.With interest rates already low on CASA
deposits, a bank is unlikely to want them any lower a's it will risk losing customers, Moody's said
For instance, state-run State Bank of India has linked its savings deposit rate to the repo rate, but subject to the savings deposit rate
not falling below 3 per cent.Secondly, the lack of a single benchmark that can consistently and accurately capture the movement of interest
rates in the economy will also cause volatility to banks' NIMs
Benchmark selection will be difficult and will cause inherent volatility to banks' NIMs.Thirdly, banks' funding requirements are dynamic
with periods when a particular bank's funding needs are high and it will readily pay higher than market rates, and vice versa
The new rules will impede the ability of banks to reflect such changes in funding costs of their lending rates as these will be linked to an
external benchmark.The new rules will be applicable only to new personal, retail and MSME loans
Therefore, according to Moody's , the near-term impact will be mitigated as new loans will be a relatively small portion of banks' loan
books to begin with.The report said RBI's mandate will affect all rated Indian banks, although in varying ways."For banks with strong
deposit franchises, the volatility in interest rates in the economy will have a bigger impact
For banks with comparatively weaker deposit franchises, the volatility of their own funding costs will have a bigger impact," it said.Get
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