The Reserve Bank of India’s (RBI) decision to allow banks to reduce the spread component on loans offered before three years will benefit existing customers and further aid monetary policy transmission, experts said.
In order to benefit existing borrowers, the RBI, on Monday, said, “…the other spread components may be reduced by banks for a loan category earlier than three years for customer retention, on justifiable grounds, in a non-discriminatory manner, and in terms of the bank’s policy”. The new norms will come into effect from October 1.
Spread refers to the additional percentage that lenders add to the benchmark interest rate such as external benchmark rate or marginal cost of funds based lending rate (MCLR) by banks when determining the final lending rate to a borrower. Banks typically factor in credit risk profile, operating cost and tenure of the loan while finalising the spread charged to a borrower.
Earlier the spread charged to a borrower could be altered once in three years.
Banks often attract customers from other banks by offering lower interest rates on new loans. However, the existing regulatory framework may constrain the ability of banks to reduce lending rates for current borrowers, said Anil Gupta, senior vice president and co-group head at ICRA Ltd.
“In this context, introducing greater flexibility to reset lending rates in favour of existing customers is a welcome move and could enhance borrower benefits,” he said.
The RBI introduced the external benchmark-based lending rate (EBLR), linked to the repo rate or to three- or six-month Treasury Bills, in October 2019. All retail loans offered by banks are linked to the repo rate.
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Earlier, in a rate easing cycle, existing borrowers only benefited to the extent of reduction in the repo rate. However, under the new RBI regulations that allow banks to reduce the spread, lenders will also be able to offer lower and competitive loan rates to existing borrowers, market analysts said.
This will help in monetary policy transmission in the outstanding loans, bankers said.
The repo rate has been reduced by 100 basis points (bps) between February and June 2025. In response to this, the weighted average lending rate on fresh rupee loans of scheduled commercial banks has so far declined by 53 bps, while the overall transmission on outstanding rupee loans stands at 49 bps.
Floating to fixed interest rate regime
In another move, in case of personal loans, the RBI has said banks may provide borrowers the option to switch over from floating interest rate to fixed rate at the time of reset of interest rates. However, the regulator has left it to the discretion of lenders to decide whether to provide this option.
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According to Gupta, the switch over to a fixed rate loan can adversely impact the profitability of banks, especially if such a reset happens at the bottom of the interest rate cycle.
“Therefore, allowing lenders the discretion to provide such options to borrowers based on their liability profile will offer them the flexibility to manage these transitions strategically, thereby safeguarding their profitability,” he said.
Loans to jewellers
The RBI also allowed banks to grant working capital loans to jewellers. Currently, lenders are prohibited from lending for purchase of gold or silver in any form, or lending against the security of primary gold or silver such as gold bars or coins.
“It is proposed to extend the carve-out for granting any need-based working capital requirements of a borrower that uses gold as a raw material or input in its manufacturing or industrial processing activities,” the RBI said. Similarly, the RBI has also permitted tier-3 and tier-4 urban co-operative banks to grant working capital loans to these sets of borrowers.
