MUMBAI: Small businesses and those buying homes and cars on credit have a reason to cheer from the next fiscal year — at least when the Reserve Bank of India reduces key rates.

All banks will then have to align outstanding loans to a common benchmark and maintain the spread throughout its term, unless a change in the client’s credit-risk profile warrants a reset. The central bank has also announced the linking of all new floating-rate personal retail and MSMEs loans to one of the four suggested external benchmarks from FY19.

The reference gauges include the RBI policy repo rate, the Government of India 91-day Treasury Bill yield produced by the Financial Benchmarks India Private Ltd (FBIL), or the GoI 182-day Treasury Bill yield produced by the FBIL, or any other benchmark market interest rate produced by the FBIL. Final guidelines on the benchmarks will be issued by end-December. “This will introduce greater standardization for these loan categories,” said Dinabandhu Mohapatra, MD CEO, Bank of India. Banks have linked loans to the marginal cost of lending rates (MCLR) in April 2016.

“This will make interest rates transparent for borrowers,” said RBI deputy governor N S Vishwanathan. Borrowers have often complained about the lack of transparency in the process adopted by lenders to fix loan rates.

They also believe that they do not benefit from cuts in broader interest rates. An internal central bank study, chaired by Janak Raj, had recommended that high-street banks use external benchmarks for their floating rate loans instead of the present system of internal benchmarks, which include the prime lending rate, benchmark prime lending rate, base rate, and marginal cost of funds-based lending rate. “The proposal… is expected to improve transparency in loan pricing by banks as the existing benchmarks, especially the base rate, have not led to a full transmission of the benefits of declines in the cost of bank funds to borrowers,” said Karthik Srinivasan Group Head- Financial Sector Ratings, ICRA.

“For borrowers, therefore, it may lead to a more frequent reset on their EMIs.” Srinivasan added that this will lead to higher volatility in bank profits, unless the lenders are able to raise floating rate deposits linked to external benchmarks.