An internal Study Group constituted by the Reserve Bank of India RBI has recommended that banks shou...........

Economic Affairs Money Supply and Monetary Policy

An internal Study Group constituted by the Reserve Bank of India (RBI) has recommended that banks should set interest rates based on an external benchmark and not as per internal benchmarks as is the practice now. What would qualify as external benchmarks in this context?

Cost of funds for the banks
RBI’s policy repo rate
Global economic downturns

Select the correct answer using the codes below.

2 only

1 and 3 only

1 and 2 only

2 and 3 only

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Explanation:

Bank’s interest rates are decided on the marginal cost of fund based lending rate (MCLR). This is calculated based on banks’ internal factors such as cost of funds.

But, there is a problem with this method. This method of calculating interest rates (for lending) is insensitive to changes in the policy interest rate or repo rate.

Also, banks deviate in an ad hoc manner from the specified methodologies for calculating the MCLR to either inflate the base rate or prevent the base rate from falling in line with the cost of funds.

The Study Group is of the view that the T-Bill rate, the CD rate and the RBI’s policy repo rate are better suited than other interest rates to serve the role of an external benchmark.

This will make the bank’s interest rate responsive to the policy rates and RBI can easily affect the interest rates by the policy rates.