Reserve Bank of India's View on Linking NBFCs' Lending Rates with External Benchmarks
The Reserve Bank of India (RBI) has expressed concerns regarding the feasibility of linking finance companies' lending rates with external benchmarks, despite efforts to improve the weak transmission of policy rates.
Weak Transmission of Policy Rates
- The transmission of policy rates to end borrowers is notably weaker in non-banking finance companies (NBFCs) compared to banks.
- Between May 2022 and March 2025, the RBI increased the repo rate by 225 basis points (bps).
- During the same period, NBFCs passed a mere 38 bps rate hike to borrowers, while commercial banks increased rates by 105 bps.
- This indicates that the transmission of policy rates by finance companies is weak.
Analysis and Feasibility
- RBI sought to improve the analysis of the transmission of policy impulses to NBFC lending rates.
- The feasibility of introducing an external benchmark-based lending rate (EBLR) system for NBFCs to select sectors was examined for 2024-25.
- The EBLR regime, which quickens policy rate transmission, is already in place for banks' loans to home buyers and small businesses.
- Despite its potential benefits, the introduction of EBLR for NBFCs was deemed not feasible.
Current Lending Rate Systems
- Under the EBLR system, banks link lending rates to an external benchmark like the repo rate or treasury bills.
- As of December 31, 2024, about 60.6% of commercial bank loans are linked to the EBLR system.
- Approximately 35.9% are linked to the marginal cost of lending rate (MCLR), and 1.6% to the Bank Rate.
Interest Rates and Funding Sources
- NBFCs tend to charge higher interest rates compared to banks, reflecting their liability structures and the risk profile of borrowers.
- NBFCs are significantly dependent on banks for funding, highlighting the need for greater diversification of their funding sources.
- The RBI suggests that a scale-based regulatory framework could improve governance and risk management in NBFCs.
