The Reserve Bank of India (RBI) has introduced a proposal aimed at enhancing protection for borrowers with floating-rate loans. This initiative comes in response to the need for increased transparency in the manner banks adjust interest rates according to changing benchmarks. Under the proposed guidelines, primarily labelled as the Reserve Bank of India (Interest Rates on Loans and Advances) Directions, 2026, the changes could come into effect from April 1, 2027.

One notable aspect of this proposal involves the processing of existing loans. Borrowers would be required to provide consent for transitioning their existing loans that are linked to either internal or external benchmarks. All such migrations must be completed by April 1, 2029. Importantly, the new interest rate set for these loans cannot exceed the rate effective prior to the migration, ensuring that borrowers do not face increased financial burdens during this transition.

Furthermore, banks will not be permitted to charge any fees for facilitating this migration, which is intended to make the shift more manageable for borrowers currently under the existing frameworks.

Implications of Changing Loan Benchmarks

The benchmark plays a vital role in determining the interest rates of floating-rate loans, as these rates are typically calculated using a combination of the benchmark and the lender’s margin. Changes in the benchmark can substantially affect the interest rate, equated monthly instalment (EMI), and the overall duration for loan repayment. According to the proposed rules, all loan agreements must explicitly state the benchmark being used, the frequency of its potential resets, and the specific dates when such resets will occur.

Most loans will observe a maximum reset frequency of three months. Once this frequency is established, changes are generally not permissible throughout the loan’s duration, except under designated circumstances. This structure aims to bring predictability and stability to borrowers’ financial planning.

Additionally, the RBI aims to limit the flexibility banks have in modifying the spread over the benchmark. Changes to the credit-risk premium will only be permissible under specific conditions, such as alterations in the borrower’s credit profile, and following a comprehensive review. Other elements of the loan spread—including operating costs and strategic premiums—cannot typically be adjusted for three years, although reductions can be made earlier for justified reasons to retain customer loyalty.

Provisions for Discontinued Benchmarks and New Loan Structures

The proposed framework also includes provisions for scenarios in which the benchmark linked to a loan is phased out. In such events, the lender would be responsible for substituting the benchmark without placing the borrower at a disadvantage. Contracts may delineate a fallback benchmark that can come into effect if the original benchmark becomes unavailable, which acknowledges the long-term nature of many loans.

Furthermore, significant adjustments will apply to the pricing of new floating-rate loans. All new personal loans and loans for micro, small, and medium enterprises (MSMEs) initiated by commercial banks will need to be linked to an external benchmark. Other financial institutions, such as non-banking financial companies (NBFCs), regional rural banks, and cooperative banks, will have the option to offer floating-rate loans tied to external benchmarks. Considerations for these external benchmarks may include the RBI policy repo rate, Government of India Treasury Bill yields, or other informative rates published by Financial Benchmarks India Pvt Ltd.

The RBI’s proposal remains in its draft phase and is subject to alterations following stakeholder consultations. Consequently, any potential benefits these guidelines may offer should not be viewed as finalised rules until the framework is officially ratified. If implemented as suggested, the new guidelines could significantly clarify the mechanics surrounding how floating-rate loans are priced and how adjustments to benchmarks will be managed.

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