There are two categories of lending rates i.e. Internal benchmark lending rates & External benchmark lending rates.
Internal Benchmark Lending Rates :- Under this method, RBI gives certain guidelines to the banks on the basis of which they decide their own lending rates . As banks have the authority to decide the lending rate, such method of lending rate is called Internal Benchmark Lending Rate.
Since , there were many drawbacks in this system, therefore, RBI recently announced its intention to make it mandatory for all banks to link floating rate loans — to retail customers and loans to micro, small and medium enterprises (MSME) — to an external benchmark to be effective from 1st October, 2019.
External Benchmark Lending Rate :- Under this system, Banks can choose from one of the four external benchmarks — repo rate, three-month treasury bill yield, six-month treasury bill yield or any other benchmark interest rate published by Financial Benchmarks India Private Ltd. This system was first proposed by the former governor Urjit Patel in 2018.
FEATURES OF EXTERNAL BENCHMARK LENDING RATE SYSTEM :-
- The external benchmark lending rate is decided by the banks based on the cost of CRR, Operational expenses and profit margin.
- These external benchmark linked loans can be offered by the banks to other borrowers also.
- A uniform external benchmark must be adopted by the bank in a particular loan category to ensure transparency and standardization.
- Existing borrowers can shift to external benchmark at mutually acceptable terms.
- RBI has mandated banks to reset interest rates under external benchmark at least once every three months from the earlier practice of resetting interest rates once a year under MCLR.
- It ensures transparency and standardization.
- It ensures faster transmission of monetary policy rates.
- There is frequent change in lending rates since the benchmarks under this system are highly unstable .
- Even if banks link lending rates to the same external benchmark, the initial base or benchmark would vary across banks. E.g. for SBI repo rate lending rate (RLLR) is 7.65 percent currently and for IDBI Bank, it is 8.3 percent.
Thus, external benchmark lending rate system can simply be referred to as an effective move which can help in giving a much needed boost to retail lending system and ultimately boost the consumption.