The Reserve Bank of India on Wednesday asked lenders to link new floating rate loans to external benchmarks in order to improve transparency. Personal or retail loans, as well as small business loans based on floating rate, will be linked to an external benchmark starting 1 April 2019. The final guidelines regarding this will be issued by the central bank by the end of December.

Banks will be given the discretion to decide on the spread when the loan is issued but that should remain constant throughout the period of the loan unless there is a change in the borrower's credit score.

Lenders can choose from RBI's repo rate, the 91-day T-bill yield, the 182-day T-bill yield and any market interest rate produced by the FBIL, as their external benchmark.

The RBI has earlier made linking base rate to the marginal cost of funds-based lending rate mandatory. Linking interest rates to external benchmarks make them transparent for borrowers and help reflect the global rate environment better. It will, however, be challenging for interest-rate management by banks.

The new loan pricing mechanism is based on the recommendations of an internal study group chaired by Janak Raj at the RBI in October 2017. It comes three years after MCLR (marginal cost lending rates) system was introduced in 2016, which replaced the 'base rate.' The MCLR was introduced to reflect the changes in policy rates by the central bank. Earlier, banks were slow to make the adjustment.