After exactly six months since then, Reserve Bank of India (RBI) has now directed the banks to bring all floating rate loans to medium enterprises also under the external benchmark-linked regime from April 1, 2020 onwards
RBI believes this would strengthen the monetary policy transmission of interest rates. RBI said subsequent to the introduction of the external benchmark system, the monetary policy transmission has improved in respect of the sectors where new floating rate loans have been linked to the external benchmarks.
The RBI move last year to bring all retail and micro & small enterprises loans under the external benchmark system was to make sure that the RBI’s action on key policy rates get transmitted in a timely and transparent manner to the end user – the borrower, which never happened earlier, despite the RBI efforts in that direction.
MCLR and Base Rate regimes
It was on April 1, 2016, all retail loans such – car and home loans, etc, were linked to marginal cost of funds-based lending rate (MCLR), which was a rate linked to the bank’s cost of funds.
In fact, the MCLR-based regime had replaced the earlier ‘Base Rate’ regime with a view to providing greater transparency in the transmission of monetary policy decisions.
Both Base Rate and MCLR regimes were very much dependent on the respective banks’ cost of funds and had always lagged behind the policy rates the RBI would introduce through their bi-monthly monetary policy announcements.