Moody’s Investors Service in its latest report has said that the Reserve Bank of India’s (RBI) direction to banks to link all new floating rate personal and retail loans, along with loans to micro and small enterprises (MSEs) to external benchmarks with effect from October 1, is credit negative for banks as it will limit their flexibility in managing interest rate risk. It mentioned this could cause volatility in net interest margins (NIMs), in turn translating into volatility in the overall profitability of banks.
It added the lack of a single benchmark that can consistently and accurately capture the movement of interest rates in the economy will also cause volatility to banks’ NIMs. It further highlighted that under the new rules, the direct linkage between lending rates and funding costs will no longer exist. This will expose banks to asymmetrical movements in the cost of funding and loan yields, exposing them to interest rate risks.
Currently, banks’ floating rate loans are benchmarked to the marginal cost of funds-based lending rates (MCLR). With changes in lending rates aligned to changes in the cost of funding, banks are able to mitigate their interest rate risk.