MUMBAI: The age of transparent loan pricing, ushered in with the External Benchmark Lending Rate (EBLR) in 2019, was meant to be a borrower’s paradise.
With loan rates directly linked to the RBI’s repo rate (or treasury), every central bank rate cut was expected to be a direct benefit to millions of borrowers.
But a surprising and subtle shift is now underway, with India’s banks strategically pivoting to protect their own profits, challenging the very spirit of the EBLR regime.
The philosophy behind this emerging trend is a simple, yet powerful one: after a series of aggressive rate cuts by the RBI, banks are now actively pushing to lock in their lending margins by moving loans from a floating-rate to a fixed-rate structure.
The squeeze on margins
The story begins with the RBI’s recent “dovish pause” after a series of rate cuts totaling 100 basis points since February. While these cuts were celebrated by borrowers, they created a significant financial squeeze for banks, with several banks having witnessed drop in their net interest margin (NIM) in the recent quarters.
Unlike the earlier opaque systems of Prime Lending Rates (PLR) or MCLR, the EBLR mechanism mandates a direct and relatively quick transmission of policy rate changes.
Many banks, including Federal Bank as noted by its CEO, KVS Manian, have been passing on the repo rate cuts on a near real-time, or “T+1,” basis. This means a borrower’s EMI is reduced almost immediately after an RBI rate cut.
However, the deposit market is not as responsive. Banks are struggling with a “tight deposit market,” where they are forced to offer higher rates on term deposits to attract funds.
This mismatch – a swift decline in their lending income (from EBLR-linked loans) and a stickiness or even increase in their cost of funds (from deposits) – has put immense pressure on their net interest margins (NIMs), a key measure of profitability.
The pivot to fixed-rate loans
Faced with this profitability challenge, banks are now making a quiet but significant tactical change. The move is to increase the share of fixed-rate loans in their portfolio, even as the EBLR system was designed to make floating rates the norm.
The Thrissur-based South Indian Bank (SIB) has been, of late, promoting fixed rates loans like personal loans and gold loans. Moreover, the bank encourages short-term corporate loans in order to escape from the long ‘EBLR pinch’.
At a recent earnings call, Federal Bank CEO Manian shed light on this strategy. He reportedly noted that the percentage of fixed-rate loans in their portfolio had increased from 25 per cent to 33 per cent in recent quarters and expressed his hope to reduce the floating-rate percentage even further.
He also said the volume of EBLR loans has fallen from 51 per cent to 48 per cent and is set to fall further from that level soon
This isn’t just about one bank; it reflects a broader industry trend. Banks are actively promoting fixed-rate products in areas like car loans, gold loans and commercial vehicle loans
By doing so, they are locking in their lending rates at a time when interest rates are likely to remain steady or fall further. This allows them to secure a predictable income stream and protect their margins from the ongoing squeeze.
A twist of irony
There is a compelling irony in this development. The RBI, to protect borrowers from unpredictable rate hikes, had recently mandated that banks must offer the option to switch from a floating-rate loan to a fixed-rate loan.
While this was initially a consumer protection measure, some banks are now using it to their advantage in a rate-cutting cycle. Borrowers, seeing a low-rate environment, may be enticed by the stability of a fixed-rate loan, not realising that a further rate cut by the RBI would not be passed on to them.
This strategic pivot poses a potential threat to the transparency and consumer-centric benefits that the EBLR system was meant to deliver. While it is a savvy business move for banks struggling to maintain profitability, it raises questions about whether the era of direct transmission of monetary policy is quietly giving way to a new dynamic, where banks are once again finding ways to insulate themselves from central bank actions.
The stage is set for a tug-of-war between the central bank’s policy goals, the banks’ profit motives, and the interests of the Indian borrower.
