Draft Reserve Bank of India (RBI) rules will bar lenders from tinkering with loan spreads over the benchmark rate to offer new borrowers better deals than existing customers, standardising interest-rate setting across banks, non-banking financial companies (NBFCs) and cooperatives, according to Business Today.
The proposed framework, reported by Business Today, requires lenders to maintain the spread between the benchmark rate and the loan rate for at least three years. It also sets common parameters for spread components and requires interest on advances to be charged on monthly rests, except for specified agricultural advances, calculated on a daily reducing balance basis using the actual/actual day-count convention.
Three-year freeze on spread components
Under the draft rules, a credit risk premium can be changed only when there is a documented change in the borrower's credit profile following a comprehensive review, according to the report. Other components of the spread cannot be increased before three years from the first disbursement or the last revision. Lenders can reduce these components earlier for customer retention only on a non-discriminatory basis. The draft also states that loans cannot be priced below the applicable benchmark.
Other components of the spread cannot be increased before three years from the first disbursement or the last revision.
Benchmark reset frequency and floating-rate loans
For floating-rate loans, the benchmark reset frequency for major lenders cannot exceed three months and must remain fixed for the tenor of the loan, according to Business Today. Commercial banks will continue to link floating-rate personal loans and floating-rate loans to micro, small and medium enterprises (MSMEs) to an external benchmark. Permitted external benchmarks include the repo rate, treasury-bill yields, SORR, or benchmarks published by FBIL.
Lender categories and compliance
| Lender type | External benchmark linking | Key compliance duties |
|---|---|---|
| Commercial banks | Mandatory for floating-rate personal loans and MSME loans | Three-month maximum reset frequency; three-year freeze on non-credit risk spread components |
| NBFCs, cooperative banks, RRBs, AIFIs | Optional; may use internal or external benchmarks | Subject to reset and spread rules unless exempt |
| Smaller lenders (RCBs with deposits up to Rs 1,000 crore, Base Layer NBFCs, Tier 1 and Tier 2 UCBs) | Not specified | Exempt from the three-month maximum reset frequency and the three-year freeze on revisions to non-credit risk components of spreads |
The Business Today report noted that smaller lenders will get exemptions from some of the requirements, adding that rural cooperative banks (RCBs) with deposits of up to Rs 1,000 crore, Base Layer NBFCs, and Tier 1 and Tier 2 urban cooperative banks (UCBs) will not have to comply with the three-month maximum reset frequency or the three-year freeze on revisions to non-credit risk components of spreads.
Stricter methodology for internal benchmarks
Internal benchmarks such as the marginal cost of funds-based lending rate (MCLR) will have to follow a stricter methodology under the proposal. According to Business Today, MCLR must be based on a three-month moving average of the annualised weighted average cost of fresh domestic deposits and borrowings. The calculation must be system-generated and independently verifiable. The methodology used to calculate internal benchmarks will also have to be made publicly available, and loan agreements will have to specify the benchmark, reset periodicity and reset dates.
For finance executives and treasury teams reviewing credit facilities, the draft rules imply that lenders will no longer be able to price new loans off a lower spread than existing borrowers on the same benchmark, according to the report. Spread changes will be constrained for at least three years from origination or the last revision, with the only permissible early adjustment being a reduction for customer retention applied on a non-discriminatory basis. Benchmark choices, reset dates and calculation conventions will also become standardised and disclosed in loan agreements, giving borrowers a clearer basis for comparing funding costs across banks and NBFCs.
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