Chennai, Jan 26 (IANS) The Reserve Bank of India's (RBI) norms requiring banks to outline the framework they use to determine the loan spread about their benchmark lending rates will reduce pricing power of the latter, global rating agency Moody's Investor Services said on Monday.

An article in Moody's Credit Outlook on Jan 26 said: "The new requirements are credit negative because they will reduce banks' discretion to price loans at higher spreads to correspond to market conditions and each borrower's credit worthiness."

The norms are likely to most affect consumer loan pricing given that retail borrowers tend to have less pricing power than large industrial borrowers and banks have been most able to take advantage of market inefficiencies in the retail loan segment, Moody's said.

According to the report, within the retail segment, pricing in the mortgage segment is likely to be the most affected as it is in this segment that banks have resorted to differential pricing the most.

Indian banks are required to set a base lending rate that is a function of the bank's cost of funding, operating costs and cost of capital.

"Although banks are not allowed to lend at rates below their base rate, they have latitude in how they charge a premium or spread on individual loans, depending on market conditions and the credit quality of the specific borrower," the report stated.

According to Moody's, RBI's concern about the transparency and fairness of how banks determine loan spreads mainly relate to the downward stickiness of lending rates (i.e., lending rates not declining commensurately with other interest rates), discriminatory treatment of old borrowers versus new borrowers and arbitrary changes in spreads.

Bank spreads are a function of product-specific operating costs, credit risk premium, the loan tenor and qualitative factors such as competitive intensity and pricing power.

"The regulator has been concerned that arbitrary inclusion of these qualitative factors into product pricing can lead to spread disparities among customers. The new norms address this by requiring banks to have a board-approved policy delineating the spread components," the report noted.

"We expect this to reduce the arbitrariness in determining spreads for specific customers," Moody's said.

According to the rating agency, the spread charged to an existing borrower may not be increased except on account of deterioration in the borrower's risk profile or when market interest rates for that particular loan tenor have increased.

If a bank decides to change its spreads because of a change in market interest rates for a particular loan tenor, the change will also be applied to all the bank's borrowers at that particular tenor, Moody's said.