RBI Draft: NBFCs Get Optional External Benchmark Loans

The Reserve Bank of India (RBI) has issued new draft norms for Interest Rates on Loans and Advances, proposing that non-banking financial companies (NBFCs), all-India financial institutions, regional rural banks, and cooperative banks will have the option to link their loans to external benchmarks. This approach differs from commercial banks, which must continue to link floating-rate retail and MSME loans to such benchmarks.

Discretion in Loan Rate Linking

The draft framework grants these specific regulated entities the flexibility to offer external benchmark-linked floating rate loans to any borrower segment as they deem fit. This means they are not mandated to adopt external benchmarks, unlike their commercial banking counterparts.

• Non-banking financial companies (NBFCs)
• All-India financial institutions
• Regional rural banks
• Cooperative banks

Safeguarding Borrowers from Usury

A significant focus of the draft is to prevent excessively high interest rates, particularly for smaller loans. It mandates that all regulated entities must establish an explicit ceiling on the Annual Percentage Rate (APR) for specific loan categories.

• For microfinance loans and small-value loans up to ₹50,000, the APR, including all charges, must have an explicit ceiling.
• Short-term agricultural loans for small and marginal farmers cannot have total interest and charges exceeding the principal amount.

Phased Transition to New Framework

The RBI has also outlined a clear migration path for all existing loans to transition to the new system, ensuring a smooth shift for borrowers. This comprehensive process includes several critical steps to protect consumer interests during the changeover.

• All loans must be transitioned by April 1, 2029.
• A one-time mapping exercise is required for this migration.
• Borrower consent is mandatory for the transition.
• The interest rate applicable immediately before the transition cannot be increased.
• No charges can be levied for the migration process.

The RBI’s overall objective is to ensure effective monetary policy transmission, facilitate appropriate credit risk pricing, and guarantee fair treatment of borrowers. This new framework aims to replace existing disparate guidelines with a broad, principles-based approach for interest rate determination across all regulated entities.

How Interest Rates Will Be Determined

Under the proposed framework, interest rates for both fixed and floating-rate loans will be set by referencing an internal or external benchmark, combined with a risk-based spread. Crucially, loans cannot be priced below the applicable benchmark rate.

• The benchmark, reset periodicity (generally not exceeding three months), and reset date must be specified in the loan agreement for floating-rate loans.
• A board-approved policy is required for determining the spread, which includes components like credit risk premium (CRP), operating cost, and term premium.
• The CRP can only be revised if the borrower’s credit profile changes.
• Other spread components generally cannot be revised before three years for floating-rate loans, with exceptions for customer retention.
• Interest will be computed on a daily reducing-balance basis.

This structured approach aims to provide clarity and consistency in how interest rates are calculated and applied across the diverse landscape of regulated financial entities in India.