RBI eases Interest Rate norms for lenders

Offering fixed option not mandatory at reset; Banks can pass benefits of reduced cost to borrowers before 3 years

– Yuvraj Kundargi | Executive, finserv@vinodkothari.com

The Reserve Bank of India issued amendment directions on September 29, 2025^[1] that modify the extant guidelines that govern floating interest rate loans. They provide that:

• Reduction in costs owing to reduction in components of spread (other than credit risk premium) can be passed to customers in a shorter time frame, that is, even before 3 years, and
• that lenders are not obligated to offer fixed loan options to borrowers when floating rates are reset.

These amendments are poised to address the capabilities of lenders by improving transmission of low costs and reducing operational complexities. A brief overview of changes follows:

• Conversion to Fixed rate is now optional:

Vide amendment to Reset of Floating Interest Rate on Equated Monthly Instalments (EMI) based Personal Loans applicable to banks as well as NBFCs.

The old circular stated that REs had to compulsorily provide the option to borrowers to switch over to a fixed rate as per their Board approved policy. Even in cases when the RE did not have any fixed rate personal loan products, it was mandated to offer such an option, and thus mandated to offer fixed rate loan products.

The amended circular enables REs to optionally providea choice to borrowers to switch to fixed rate loans, but does not make it mandatory for them to do so. Thus, they do not need to offer fixed rate loan products, reducing the complexity of their operations.

In India, banks have traditionally extended floating-rate loans, particularly for long-tenure lending, without absorbing the underlying interest rate risk. The regulatory compulsion to provide borrowers with the option to convert to fixed rates placed lenders in a difficult position, as they were effectively pushed to offer a product they were neither structurally prepared for nor inclined to provide.

One could argue that banks, being better positioned to manage interest rate risk, might eventually have developed fixed-rate loan offerings for longer maturities, especially since India’s interest rate environment has historically been less volatile than economies where fixed-rate loans remain a norm. However, to avoid exposing banks to the embarrassment of being unable to practically deliver such products, the RBI appears to have stepped in, making the provision of this conversion option itself optional.

• Passing benefit of cost reduction: Vide amendment to Master Direction – Reserve Bank of India (Interest Rate on Advances) Directions, 2016, RBI has permitted banks to pass the benefit of reduced cost to the customer.

Under the old guidelines, the other components of the spread (other than credit risk premium) such as operating costs and liquidity costs could only be changed once every three years. Thus, any major changes to the bank’s costs, such as a reduction in operating costs, could not be easily passed on to its customers.

With the amendment, such costs may be reduced by banks earlier than three years for customer retention, ensuring that any benefit the bank gets in terms of lower cost is passed on effectively to customers. This must be included in the bank’s policy and must be non-discriminatory, ensuring transparency and fairness. A leaner performance by Banks now enables them to offer better rates sooner, of course supporting a better customer outreach.

^[1] That will come into effect from October 01, 2025

Our Resources on the topic:

a. FAQs on Reset of Floating Interest Rate on Equated Monthly Instalments (EMI) based Personal Loans