December 17, 2015 / 1:51 PM / 2 years ago

UPDATE 1-India cenbank announces new rules for how banks can set lending rates

* Banks must move to marginal cost based lending from April 1

* Existing loans largely excluded from new rules

* Banks must review lending rate every month (Updates to add details)

By Suvashree Choudhury

MUMBAI, Dec 17 (Reuters) - India's central bank on Thursday set new rules on how banks can calculate their lending rates, making them more closely based on market rates and removing some of the freedom lenders now enjoy in order to allow quicker transmission of monetary policy.

According to the new rules, banks must set their lending rates under their so-called marginal cost of funding every month, which will be based on the rate offered on new deposits. That would force banks to better reflect market rates given deposits track money markets in India.

Under the current system banks set their lending rates based on the average rate of outstanding deposits, a system that had given them more freedom to determine how much to charge.

The Reserve Bank of India (RBI) said the rules, which closely track draft guidelines issued in September, will come into effect on April 1, 2016.

"Apart from helping to improve the transmission of policy rates into the lending rates of banks, these measures are expected to improve transparency in the methodology followed by banks for determining interest rates on advances," the RBI said in a statement.

"The guidelines are also expected to ensure availability of bank credit at interest rates which are fair to the borrowers as well as the banks."

Each month banks must also publish the benchmarks they use in setting their marginal cost of funds in order to improve transparency.

RBI Governor Raghuram Rajan has repeatedly expressed his frustration over banks' reluctance to quickly lower their lending rates even as the central bank has aggressively eased its interest rates.

The RBI has cut its policy repo rate by 125 basis points since January, while banks have lowered their base lending rate by an average of 60 bps as of earlier this month.

Banks have opposed the rules, saying tracking deposit costs based on market rates can make lending rates too volatile, hurting their profit margins.

In a concession to lenders, the RBI said on Thursday that banks would not need to change lending rates for existing loans. The rules will only apply to new loans or to existing loans that are up for renewal, as long as the borrower agrees, it said.

For RBI statement, see: bit.ly/1NraCAo (Editing by Rafael Nam and Gareth Jones)

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