RBI's new framework to ease loan comparisons: How will transparency benefit borrowers?

The Reserve Bank of India (RBI) has proposed clearer rules for banks and non-banking financial companies (NBFCs) on loan spreads and annual percentage rates (APR) to enhance transparency in borrowing. The draft aims for a unified framework by 1 April 2027, allowing better comparison of loan costs, including a ceiling on APR for small loans to prevent borrowing costs from becoming unfairly high.

Revising the spread charged over benchmark rates on retail, personal and business loans, RBI's new framework aims to simplify loan comparisons for consumers while ensuring that non-credit-risk components of spreads remain fixed for three years. Let's find out how transparency will benefit borrowers.

Currently, it is difficult for borrowers to compare loans due to lack of transparency as banks determine spreads over benchmark rates through internal policies. Moreover, NBFCs can decide their own benchmarks which results in different pricing methods across lenders.

External benchmark such as the repo rate, Government of India Treasury Bill yields, Secured Overnight Rupee Rate (SORR), or another Financial Benchmarks India Pvt. Ltd. (FBIL) benchmarks are used by banks when deciding floating-rate retail loans, such as home loans, and MSME loans. Notably, banks' funding costs are more closely linked to policy rates as they fund themselves through RBI-regulated deposits. Wholesale funding offer greater pricing flexibility to NBFCs and housing finance companies (HFCs) as their costs may or may not align with not with the repo rate.

Through the new framework covering regulated entities (REs), including commercial banks, cooperative banks and NBFCs, RBI aims to address the issue of lack of transparency, unexplained rate changes and delayed transmission. A floating loan rate consists of mainly two components — a benchmark rate and a spread while the latter can include a credit risk premium, operating costs and other commercial considerations.

The draft guidelines mandate that non-credit-risk components of the spread cannot be changed for three years. However, the credit-risk premium can be adjusted if the borrower’s credit profile changes, provided a thorough review happens. To ensuring faster transmission of benchmark rate revisions to borrowers, the draft mandates a maximum three-month reset frequency for floating-rate loans. Small rural and urban cooperative banks and Base Layer NBFCs are exempt from this requirement.

Suggesting that the new rules could make pricing easier to understand, CEO and co-founder of Finbox, Rajat Deshpande said, “Breaking the spread into named components, such as credit risk premium, operating cost, term premium, business strategy premium, makes comparing that of banks and NBFCs, possible for the first time,” as reported by Mint. He further emphasized that the proposal standardizes pricing disclosure over charges.

To prevent borrowing costs from becoming unfairly high, RBI proposed a board-approved ceiling on APR on personal loans of up to ₹ 50,000.