For most of India's post-independence history, the RBI told banks what to charge. Lending rates were prescribed by sector, by size, by borrower category. Deposit rates were fixed by tenor. The entire interest rate structure was an administered price — set by committee, adjusted by circular, disconnected from market forces. When the RBI cut the repo rate, nothing happened to your home loan EMI because nothing connected the two.
The deregulation took thirty years and four regimes. Each one failed in its own way, and each failure drove the next reform. The Prime Lending Rate was supposed to be a floor but became a fiction. The Base Rate banned sub-floor lending but left banks free to ignore repo rate cuts. MCLR tied rates to marginal funding costs but let banks game the calculation. Only the External Benchmark Lending Rate — mandated from October 2019 — finally linked retail loan rates to a rate the RBI directly controls. The transmission problem that haunted Indian monetary policy for two decades was solved not by persuasion but by plumbing.
Regime 1: PLR and BPLR (Pre-2010) — The Opaque Floor That Was Not
The Benchmark Prime Lending Rate was the reference for all bank lending. In theory, it set a floor. In practice, banks lent below it routinely — sometimes well below — for preferred corporate clients. The rate meant to be a floor became a ceiling for retail borrowers and a fiction for everyone else.
Export credit got its own concessional regime. The April 2004 export credit circular prescribed rates at "not exceeding BPLR minus 2.5 percentage points" for pre-shipment credit up to 180 days — a directed lending subsidy embedded in the interest rate framework.
The derivatives infrastructure was laid separately. The July 1999 FRA/IRS circular allowed banks to manage interest rate risk for the first time:
"The Reserve Bank of India has decided to allow scheduled commercial banks, primary dealers and all-India financial institutions to undertake Forward Rate Agreements/Interest Rate Swaps as a product for their own balance sheet management and for market making purposes."
Plain vanilla only. No caps, floors, or collars. Corporates restricted to hedging. But this was the infrastructure that later enabled banks to manage their balance sheets when lending rates became market-determined.
The RBI's Working Group on Benchmark Prime Lending Rate exposed how badly the system was broken: Working Group on Benchmark Prime Lending Rate (PR_20897). Sub-PLR lending had become the norm rather than the exception, making the benchmark meaningless as a signal of actual lending costs.
Regime 2: Base Rate (July 2010 -- March 2016)
The Base Rate guidelines (since withdrawn) ended the sub-PLR fiction. The key change: no lending below the Base Rate, period. Every bank had to publish its Base Rate, and no loan to any borrower could be priced below it.
But transmission remained sticky because each bank calculated its own Base Rate using its own cost structure — average cost of deposits, not marginal. When the RBI cut the repo rate by 50 basis points, a bank funding itself primarily through three-year fixed deposits felt no immediate pressure on its average cost. The rate cut entered the deposit book only as old deposits matured and were repriced. By the time the Base Rate moved, the RBI had often already moved on to the next policy action.
The RBI announced the shift with: Base Rate System from July 1, 2010 (PR_22153). The intention was sound. The execution revealed that a benchmark tied to average costs cannot transmit marginal changes in monetary policy.
Regime 3: MCLR (April 2016 -- September 2019)
The Master Direction on Interest Rate on Advances (Master Direction - Reserve Bank of India (Interest) mandated the Marginal Cost of Funds based Lending Rate — theoretically linked to the marginal (not average) cost of deposits, so rate cuts would transmit faster. Banks had to calculate MCLR monthly across multiple tenors, and existing borrowers could switch from Base Rate to MCLR at the next reset date.
In practice, banks gamed the marginal cost calculation. The marginal cost of deposits is not a simple number — it depends on how you weight short-term versus long-term funding, whether you include inter-bank borrowings, and how you treat the CRR drag. Each bank made different choices. Transmission improved but not enough. A 75 basis point repo rate cut might translate into 30-40 basis points of MCLR reduction, and even that reduction would reach existing borrowers only at the next annual reset.
The RBI clarified the system: RBI clarifies its Directions on MCLR System (PR_36596). But clarification could not fix the structural problem. As long as banks set their own benchmark using their own methodology, they had every incentive to set it high and cut it slowly.
Regime 4: External Benchmark (October 2019 -- Present)
The same Master Direction mandated that all floating rate retail and MSME loans be benchmarked to an external rate — the repo rate, Treasury bill yields published by FBIL, or any other FBIL-published benchmark. Banks can add a spread, but the spread is locked:
"The credit risk premium charged to an existing borrower shall not be increased except on account of deterioration in the credit risk profile of the customer or change in tenor premium."
This is the regime that works. When the RBI cuts the repo rate by 25 basis points, every home loan and MSME loan linked to the repo rate adjusts within the next reset period. The minimum reset frequency is three months. The transmission that eluded three previous regimes arrived through the simplest mechanism: tying the lending rate to a rate the RBI directly controls.
The chain is complete: PLR (opaque, fiction) to BPLR (disclosed, still a fiction) to Base Rate (real floor, no transmission) to MCLR (marginal cost, gamed transmission) to EBLR (external, direct transmission). Each regime was a response to the failure of its predecessor.
The Deposit Side: The Rs 1 Lakh Line
While lending rates were progressively deregulated, savings deposit rates followed their own path. The Commercial Banks Interest Rate on Deposits Direction (Reserve Bank of India (Commercial Banks – Interest) preserves the structure: a uniform interest rate on savings balances up to Rs 1 lakh, with differential rates permitted only above that threshold. Below the line, every depositor earns the same rate regardless of which bank they choose. Above it, banks compete.
Term deposit rates are fully deregulated — banks set their own card rates by tenor. But the Rs 1 lakh savings threshold remains the last administered price in the deposit structure, a legacy of the era when every rate was set by circular.
The Penal Charges Reform (January 2024)
The August 2023 circular (RBI/2023-24/53) (since withdrawn) changed the fundamental character of penalties on loan defaults:
"Penalty shall be treated as 'penal charges' and shall not be levied in the form of 'penal interest' that is added to the rate of interest. There shall be no capitalisation of penal charges."
"The intent of levying penal charges is essentially to inculcate credit discipline and such charges are not meant to be used as a revenue enhancement tool."
Banks had been adding penal interest on top of the contractual rate — compounding the penalty into the outstanding principal. A borrower who missed one EMI would pay interest on the penalty for the remaining life of the loan. The reform separated the penalty from the interest rate, making it a flat charge rather than a compounding addition. And it added an equity provision: penal charges for individual borrowers cannot be higher than those for non-individual borrowers. Banks had been charging retail customers more than corporates for the same kind of default.
The MPC Framework: Where Rate Decisions Begin
The Monetary Policy Committee — constituted under the amended RBI Act with three RBI members and three external members — sets the repo rate that now drives the entire external benchmark regime. The first MPC resolution in October 2016 cut the repo rate by 25 basis points. The August 2025 resolution (PR_60957) demonstrated how the external benchmark regime now directly links MPC decisions to retail lending rates. The plumbing that four regimes tried to build is finally connected.
Read the Full Story
- From MCLR to EBLR — why your home loan rate finally moves with the repo
- How Interest Rate Policy Actually Works — from MPC vote to your EMI
- The Rs 1 Lakh Line — how one threshold shapes who earns what on savings
- Where Your Deposit Interest Comes From — and where unclaimed money goes
Governing Directions: Reserve Bank of India (Interest Rate on Advances) Directions, 2016 (Master Direction - Reserve Bank of India (Interest) | Reserve Bank of India (Commercial Banks -- Interest Rate on Deposits) Directions, 2025 (Reserve Bank of India (Commercial Banks – Interest)
Last updated: April 2026