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Moody's: India's new requirement on loan pricing is credit negative for banks

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Moody's: India's new requirement on loan pricing is credit negative for banks

Indian central bank's new requirement for banks to link their lending rates on floating-rate loans to retail, personal and micro, small and medium enterprises borrowers to an external benchmark is credit negative for the country's banks, Moody's said.

The rating agency said Sept. 12 that the central bank's requirement will limit banks' flexibility in managing interest rate risk. In addition, the new requirement will hinder banks' ability to reflect changes in funding costs of their lending rates.

Earlier in September, the Reserve Bank of India said it was requiring banks to link all new floating rates for personal and retail loans, along with loans to MSMEs, to an external benchmark, effective Oct. 1, to allow for the faster transmission of rate cuts. Currently, banks' floating-rate loans are benchmarked to the marginal cost of funds-based lending rate. The new requirement would remove the direct link between lending rates and funding costs, which will expose banks to interest rate risks.

Moody's said the lack of a single benchmark that can consistently and accurately obtain the movement of interest rates will cause volatility to banks' net interest margins.