RBI draft rules on interest rates: External benchmark optional for NBFCs | Finance News

The Reserve Bank of India (RBI) has proposed that external benchmark-linked loans be made optional for non-banking finance companies (NBFCs), while emphasising that usurious rates are not charged for small-ticket loans in the draft norms on interest rates on loans and advances.

 

The draft, which offers a harmonised framework for determining interest rates on loans across regulated entities, said floating-rate retail loans and floating-rate loans to micro, small and medium enterprises (MSMEs) extended by commercial banks would have to be linked to an external benchmark, as is the norm now.

 

However, this requirement would not be mandatory for NBFCs, all-India financial institutions, regional rural banks and cooperative banks. These entities “may, at their discretion, choose to offer external benchmark linked floating rate loans to any category of borrowers,” the RBI said.

 
 

Furthermore, the draft said all regulated entities should ensure interest rates on loans up to ₹50,000 should not be usurious and explicitly put a ceiling on annual percentage rate.

 

“A RE shall explicitly put a ceiling on the Annual Percentage Rate (APR) inclusive of interest rate and all other charges / fees on microfinance loans and small-value loans while ensuring that these are not usurious,” the draft said.

 

For short-term agricultural loans to small and marginal farmers, total interest and all other charges and fees cannot exceed the principal amount, it added. A short-term loan is defined as one with an original tenor of up to one year.

 

All loans should be migrated to the new framework through a one- time mapping exercise by April 1, 2029. The migration would require borrower consent and could not increase the interest rate applicable immediately before the transition. Lenders would also not be allowed to levy charges for the migration.

 

The RBI said its interest-rate instructions have been aimed at “ensuring effective monetary policy transmission, appropriate pricing of credit risk, and fair and non-discriminatory treatment of borrowers”. At present, detailed lending-rate regulations are largely applicable to commercial banks, while instructions for other regulated entities, including NBFCs, are “largely with regard to conduct-related aspects”.

 

The central bank also said it had observed ‘divergent practices’ among commercial banks in areas including determination of the marginal cost of funds-based lending rate (MCLR) and its components.

 

“Accordingly, it is proposed to issue harmonised Directions for all REs, prescribing a broad, principles-based framework for the determination of interest rates on both fixed-rate and floating-rate loans,” the RBI said.

 

Under the proposed framework, interest rates on fixed- and floating-rate loans would be determined with reference to an internal or external benchmark plus a risk-based spread. A lender would not be allowed to price a loan below the applicable benchmark. For floating-rate loans, the benchmark, reset periodicity and reset date would have to be specified in the loan agreement, with the benchmark generally reset at intervals not exceeding three months. This requirement would not be mandatory for NBFCs in the Base Layer and certain smaller cooperative banks.

 

The draft also proposes a board-approved policy for determining the spread over the benchmark. The spread could comprise a credit risk premium (CRP), operating cost, term premium and business strategy premium. The CRP could be revised only when the borrower’s credit profile changes and after a comprehensive review. Other components generally cannot be revised before three years for a floating-rate loan, although lenders can reduce them earlier for customer retention on justifiable and non-discriminatory grounds. These restrictions would not be mandatory for Base Layer NBFCs and certain smaller cooperative banks.

 

The framework would also explicitly cover fixed-rate loans, which would be priced with reference to an internal or external benchmark plus a risk-based spread and could not be priced below the applicable benchmark. Where a loan switches between fixed and floating rates, the respective provisions would apply during the relevant periods.

 

Interest would be computed on a daily reducing balance basis, using the actual/actual day-count convention.

 

If a benchmark is discontinued during the tenure of a floating-rate loan, the lender would have to change the benchmark without putting the borrower at a disadvantage in terms of the applicable interest rate.

 

The RBI said the proposed directions would provide a “broad, principles-based framework” for interest-rate determination across regulated entities, replacing the existing directions applicable to different categories of lenders.