The Reserve Bank of India (RBI) has initiated a significant overhaul of loan pricing regulations, proposing a new framework designed to bring greater transparency and consistency to how banks and other financial institutions determine interest rates. The move aims to protect borrowers from opaque or excessive charges, particularly those accessing personal loans and micro, small, and medium enterprise (MSME) financing.
Standardizing Loan Pricing Policies
Under the proposed guidelines, all regulated lenders will be required to establish a comprehensive, board-approved policy governing the pricing of loans and advances. This policy must detail the methodology for setting interest rates, including internal benchmarks, components of spreads, loan categories, and the delegation of pricing authority. Lenders will also be mandated to review this policy at least once annually.
The RBI noted discrepancies in how banks currently determine the marginal cost of funds-based lending rate (MCLR), an internal benchmark. The new framework seeks to address these inconsistencies and expand regulatory oversight to fixed-rate loans, where existing instructions were previously limited.
Fixed and Floating Rate Loan Adjustments
- Fixed-Rate Loans: For fixed-rate loans, interest rates must be determined with reference to an internal or external benchmark, combined with a risk-based spread. Crucially, lenders will not be permitted to price any loan below the applicable benchmark.
- Floating-Rate Loans: A similar structure applies to floating-rate loans, where the interest rate will comprise a benchmark and a risk-based spread. Significantly, the RBI has proposed that all floating-rate personal loans and advances to MSMEs offered by banks must be linked to an external benchmark. This measure is intended to improve the transmission of monetary policy changes to borrowers and ensure credit pricing accurately reflects underlying risks.
Existing loans currently linked to other benchmarks will need to migrate to the proposed framework by April 1, 2029.
New Internal Benchmark Calculation
For commercial banks and other lenders with total deposits exceeding ₹1,000 crore, the internal benchmark will be based on the marginal cost of funds. The RBI suggests calculating this as a moving average of the marginal costs of domestic deposits and borrowings over the preceding three months. Such lenders will also be required to publish their internal benchmark on the first calendar day of every month, further enhancing transparency.
Safeguards for Small-Value Loans
In a crucial step to protect vulnerable borrowers, the central bank has proposed specific safeguards against the excessive pricing of microfinance and small-value loans. Lenders will be required to establish a ceiling on the annual percentage rate (APR) charged on these loans, ensuring that rates are not usurious. An APR represents the total annual cost of credit, encompassing both interest and other associated charges. Under the proposal, a personal loan of up to ₹50,000 would qualify as a small-value loan.
Once finalized, the framework will apply broadly across the financial sector, affecting banks, non-banking financial companies (NBFCs), cooperative banks, mortgage lenders, and all-India financial institutions. The RBI has invited public comments on these draft proposals until September 11, with the new rules slated to take effect from April 1 next year.