EXTERNAL BENCHMARK-BASED LENDING RATE (EBLR)
- An External Benchmark Linked Lending Rate (EBR or EBLLR) is a lending rate used by banks in India to set interest rates on loans such as home loans, personal loans, and other retail loans. This system was introduced by the Reserve Bank of India (RBI) to ensure more transparent and effective transmission of changes in policy rates to borrowers.
- Under this system, banks link their lending rates directly to external benchmarks like the RBI's repo rate, government treasury bill yields, or any other RBI-approved benchmark. The idea behind this is to ensure that changes in lending rates by banks are closely aligned with changes in the external benchmark, offering more immediate benefits to borrowers when there are changes in the broader interest rate environment.
- The external benchmark linked lending rate system ensures that borrowers experience faster transmission of changes in policy rates, making borrowing rates more responsive to changes in the economy. Banks are required to reset interest rates on loans linked to external benchmarks periodically, ensuring that changes in the benchmark rates are quickly reflected in the interest rates offered to borrowers.
- This system was introduced to bring more transparency, fairness, and efficiency in the transmission of monetary policy changes to end borrowers, providing them with the benefit of interest rate movements in a more timely manner
|Linked to external benchmarks (e.g., RBI's repo rate, government T-bill yields)
|Based on the bank's internal cost structure (e.g., cost of funds, operating expenses)
|Offers more transparent and immediate transmission of changes in policy rates to borrowers
|Determined based on internal factors, leading to potentially delayed transmission of policy rate changes
|Interest Rate Calculation
|Rate determined by adding a margin to the prevailing external benchmark rate
|Includes factors like the marginal cost of funds, tenor premium, operating expenses, and marginal profit margin
|Introduced by the RBI to improve transmission of policy rate changes and enhance transparency
|Mandated by the RBI to ensure better transmission of changes in the cost of funds to lending rates
|Adjustments in lending rates closely track changes in the external benchmark rate
|Rates reviewed and reset periodically by banks (monthly, quarterly, semi-annually) based on internal factors
|Aims for immediate transmission of policy rate changes and increased transparency in lending rates
|Ensures that changes in the cost of funds for banks are accurately reflected in lending rates
4. What is the surplus liquidity?
Surplus liquidity refers to the situation where the banking system has more funds available than needed for day-to-day operations and meeting regulatory requirements. This surplus arises when the available funds in the banking system exceed the demand for credit from borrowers.
Liquidity surplus and liquidity deficit refer to the states of excess or shortfall of funds in the banking system concerning the demand for funds. Here's a breakdown:
- Definition: Liquidity surplus occurs when there is an excess of funds available in the banking system compared to the demand for funds.
- Causes: This surplus might arise due to factors such as lower credit demand, increased deposits, interventions by the central bank injecting liquidity, or improved economic conditions where the demand for credit is low.
- Effects: Surplus liquidity can lead to lower short-term interest rates, making borrowing cheaper. It can also encourage investment and economic growth by providing more accessible credit.
- Definition: Liquidity deficit occurs when the demand for funds in the banking system exceeds the available funds.
- Causes: This deficit may occur due to increased credit demand, withdrawal of deposits, or when the central bank reduces liquidity through measures like raising reserve requirements or withdrawing funds from the system.
- Effects: Deficit in liquidity can result in higher short-term interest rates, making borrowing more expensive. It might also limit credit availability, impacting economic activities and growth.
Both liquidity surplus and deficit have implications for monetary policy, interest rates, and overall economic conditions:
Monetary Policy Impact: Central banks, like the Reserve Bank of India (RBI), often use liquidity management tools to address surplus or deficit situations. For surplus liquidity, they might implement measures to absorb excess funds, such as open market operations (selling securities to absorb liquidity). In the case of liquidity deficit, the central bank might inject funds into the system through measures like repo operations to ensure adequate liquidity.
Interest Rate Impact: Surplus liquidity tends to lower short-term interest rates, while liquidity deficit can push rates higher due to increased demand for available funds.
Economic Implications: Surplus liquidity can stimulate investment and growth by making credit more accessible, while liquidity deficit can potentially constrain economic activities due to limited credit availability and higher borrowing costs.
The two primary types of liquidity are:
Asset Liquidity: This type of liquidity refers to the ease and speed at which an asset can be converted into cash without significantly affecting its price. Assets that can be quickly sold or converted into cash without substantial loss of value are considered highly liquid. Cash is the most liquid asset since it's readily spendable. Other examples of liquid assets include marketable securities, government bonds, certain stocks with high trading volumes, and certain types of mutual funds.
Funding Liquidity: Funding liquidity refers to the availability of funds to meet financial obligations and cover short-term liabilities. It's about the ability of an entity (such as a bank, company, or individual) to obtain the necessary funds to fulfill payment obligations when due. Funding liquidity involves having access to sources of financing or cash to meet daily operational needs, pay debts, or cover unexpected expenses. For banks, funding liquidity is essential to manage withdrawals by depositors and meet regulatory requirements.
Both asset liquidity and funding liquidity are crucial aspects of financial management. Having adequate asset liquidity ensures that assets can be converted into cash if needed, providing flexibility and risk mitigation. Meanwhile, funding liquidity ensures that entities have access to necessary funds to maintain their operations, fulfill obligations, and manage financial risks without disruptions. Balancing these two types of liquidity is crucial for financial stability and managing uncertainties in the market
6. Way forward
The RBI had mandated banks to link all retail loans and floating rate loans to micro and small enterprises (MSEs) to an external benchmark – the repo rate or 3-month T-bill rate or 6-month T-bill rate or any other benchmark market interest rate published by Financial Benchmarks India Private (FBIL), effective October 1, 2019