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The Reserve Bank of India (RBI) has proposed a common framework for how regulated entities determine interest rates on loans, including provisions aimed at protecting borrowers taking small-value and short-term agricultural loans.

A key proposal is that NBFCs would not be required to link floating-rate loans to an external benchmark. The requirement would continue for floating-rate retail loans and floating-rate loans to micro, small and medium enterprises (MSMEs) offered by commercial banks.

The proposals are part of draft directions that seek to bring lending-rate practices across regulated entities under a broad, principles-based framework.

RBI Proposes Protection For Small Borrowers

The draft directs all regulated entities to ensure that interest rates charged on loans of up to Rs 50,000 are not usurious. It also proposes that lenders explicitly set a ceiling on the annual percentage rate (APR), including interest and all other charges and fees, for microfinance and small-value loans.

For short-term agricultural loans given to small and marginal farmers, the RBI has proposed that the combined interest, charges and fees should not exceed the principal amount. A short-term loan has been defined as one with an original tenor of up to one year.

The RBI said its lending-rate framework is intended to support effective monetary policy transmission, appropriate pricing of credit risk and fair and non-discriminatory treatment of borrowers, reported Business Standard.

External Benchmark Not Mandatory For NBFCs

Under the proposed framework, commercial banks would continue to link floating-rate retail loans and floating-rate MSME loans to an external benchmark.

NBFCs, all-India financial institutions, regional rural banks and cooperative banks, however, would have the discretion to decide whether to offer external benchmark-linked floating-rate loans.

These entities “may, at their discretion, choose to offer external benchmark linked floating rate loans to any category of borrowers,” the RBI said.

The central bank said existing lending-rate regulations are largely detailed for commercial banks, while rules applicable to other regulated entities, including NBFCs, mainly cover conduct-related aspects.

The RBI also said it had observed “divergent practices” among commercial banks in areas including the determination of the marginal cost of funds-based lending rate (MCLR) and its components.

How Interest Rates Would Be Determined

The proposed framework would cover both fixed- and floating-rate loans. Interest rates would be determined using an internal or external benchmark along with a risk-based spread.

Lenders would not be allowed to price a loan below the applicable benchmark.

For floating-rate loans, the benchmark, reset periodicity and reset date would have to be specified in the loan agreement. The benchmark would generally have to be reset at intervals of no more than three months.

This requirement would not be mandatory for NBFCs in the Base Layer and certain smaller cooperative banks.

The proposed framework would also require lenders to have a board-approved policy for determining the spread over the benchmark. The spread could include a credit risk premium (CRP), operating cost, term premium and business strategy premium.

The CRP could be revised only when the borrower’s credit profile changes and following a comprehensive review. Other components would generally not be allowed to change before three years for a floating-rate loan.

Lenders could reduce these components earlier for customer retention, provided the move is based on justifiable and non-discriminatory grounds. These restrictions would not be mandatory for Base Layer NBFCs and certain smaller cooperative banks.

Rules For Fixed-Rate Loans And Benchmark Discontinuation

The draft also brings fixed-rate loans explicitly within the proposed framework. Such loans would be priced using an internal or external benchmark plus a risk-based spread and could not be priced below the applicable benchmark.

If a loan moves between fixed and floating rates, the relevant provisions would apply during the respective periods.

The RBI has further proposed that interest be calculated on a daily reducing balance basis using the actual/actual day-count convention.

If the benchmark linked to a floating-rate loan is discontinued during its tenure, the lender would have to replace it without putting the borrower at a disadvantage in terms of the applicable interest rate.

New Framework To Be Implemented By 2029

The RBI has proposed a one-time mapping exercise to migrate all loans to the new framework by April 1, 2029.

Borrower consent would be required for the migration, and the transition could not result in an increase in the interest rate applicable immediately before the change.

Lenders would also not be allowed to charge borrowers any fee for migrating their loans.

The RBI said the proposed directions would provide a “broad, principles-based framework” for determining interest rates across regulated entities and replace the existing directions applicable to different categories of lenders.