MUMBAI: The Reserve bank of India’s (RBI) decision to ask banks to link all floating rate loans to external benchmarks for the retail and MSME segments is likely to lead to greater volatility in spreads.
Banks have been given the discretion to decide the spreads over the benchmark rate at the time of origination of the loan which will remain constant over the tenor of the loan.
“The net interest margin (NIM) could come under sharp pressure during declining interest rates for low spread products like housing loans. A fixed cost liability franchise could result in banks lowering the duration to reduce volatility of NIM. The ability of banks to address this risk is not clear as they would need retail floating rate deposits and interest rate hedging products,” said analysts at Kotak Securities.
According to them, the trough-to-peak interest rate change in a short period (2-3 years) as we saw post global financial crisis and taper tantrum could result in higher EMI, as the duration increase may not be sufficient. This could also raise asset quality risk as these products are high on installment-to-income ratio.
In place of the current MCLR-based loan pricing, RBI has proposed the new floating rate personal, retail and MSME loans to be benchmarked to either RBI’s repo rate, government’s 91 days Treasury Bill yield produced by the Financial Benchmarks India Private (FBIL), government’s 182 days Treasury Bill yield produced by the FBIL, or any other benchmark market interest rate produced by the FBIL.
We believe that an external benchmarking of lending yield could make margins volatile as funding cost of banks may not move in exact synchronization with benchmark rate (repo or t-bill rates).
The proposed pricing structure of floating rate loans could at some point make banks link the deposit rates to money market rates to reduce the margin volatility.
As an alternative, we believe banks could turn to swap markets to hedge the volatility in lending spreads, and create/deepen that market,” said US based financial service firm Jefferies.
