The Reserve Bank of India (RBI) has proposed a new framework aimed at creating more consistency and transparency in how lenders determine interest rates on loans. The draft rules, which are currently open for feedback, focus on both fixed and floating-rate loans, benchmark-linked lending, changes in spreads and how the existing loans are handled. If these changes go through, they could impact home loans, personal loans, MSME borrowers,especially those with floating rate loans. The proposed framework is expected to take effect from April 1, 2027.
Which banks will be covered under RBI's new draft?
The proposed guidelines will apply to commercial banks, regional rural banks, urban and rural cooperative banks, all-India financial institutions and non-banking financial companies, including housing finance companies.
Benchmark setting process for fixed rate loans
The RBI says that a lender should set the interest rate on a fixed rate loan based on either their internal benchmark or an external benchmark, plus a risk-based spread. The central bank suggests that the lender can't price a loan below the applicable benchmark for that loan.
Floating rate loans get more transparency
The RBI also has proposed that lenders must set the interest rate on a floating-rate loan using an internal or external benchmark plus a risk-based spread.
For most floating rate loans, the benchmark reset period cannot exceed three months. Once the reset frequency is chosen, it generally cannot be changed during the loan's tenor.
A lender cannot charge an interest rate lower than the applicable benchmark for that loan. The loan agreement must clearly mention the benchmark used, how often the rate will be reset as well as the reset date.
If the reset period is less than one month, the benchmark will be reset on the date on which the reset is due.
In other cases, the benchmark should be reset on the first calendar day of the month in which the reset is due.
For agricultural loans, the interest rate reset should be linked to the crop season, but the reset period cannot exceed 12 months.
Personal loans and MSME loans get a major provision
Commercial banks will need to link all floating-rate personal loans and floating-rate loans to MSMEs to an external benchmark.As per the RBI draft, "All floating rate personal loans and floating rate loans extended to MSMEs by commercial banks shall be linked to an external benchmark. Commercial banks may, at their discretion, offer external benchmark linked loans to other categories of borrowers."
MCLR calculation for banks
The RBI draft has proposed that the Marginal Cost of Funds (MCLR) should be calculated as a moving average of the marginal costs of domestic deposits and borrowings for the bank during the trailing 3-months period.
For each month, an annualised weighted average interest cost on the volume of new deposits and borrowings (which should be system generated and independently verifiable) will be used to calculate the marginal cost of funds.
Banks cannot simply keep increasing the spread
The policy has further laid down the methodology for determining the quantum of each component of the spread and the range of spread for different loan categories. The spread will consist of credit risk premium and one or more other components.
The draft identifies 4 possible components:
Credit risk premium
Operating cost
Term premium
Business strategy premium
The components of the spread may be positive or zero. However, the CRP will be positive (i.e., it shall not be zero), the RBI draft stated.
CRP will be revised only when the borrower's credit profile undergoes a change, in accordance with its policy and terms of the loan agreement.
Loan transfer: Will your interest rate change?
If a loan is transferred from one lender to another but the lender officially responsible for the loan does not change, the existing interest rate terms will continue. This includes the benchmark, spread and the rate reset rules for floating rate loans.
However, if the transfer results in a change in the lender on record and the borrower signs a new agreement with the new lender, the interest rate will be decided according to the new lender's interest rate rules.
What happens to existing loans?
All existing loans and advances linked to any internal or external benchmark will be migrated to an interest rate framework prescribed in these directions by April 1, 2029. It will be a one-time mapping exercise.
Benchmark change requires borrower's consent
If a benchmark is changed, the lender must do so with the borrower's consent and ensure that the borrower is not at a disadvantage because of the change. The new interest rate cannot be higher than the rate applicable just before the change. The lender also cannot charge any fee for the migration.
What happens if the benchmark is discontinued?
If the benchmark used for a floating rate loan is no longer available, the lender must shift to another benchmark while ensuring that the borrower isn't negatively impacted. The loan agreement may include a fallback option specifying which benchmark will be used in such a situation.
