[ecis2016.org] In a bid to ensure greater transparency and faster transmission of policy rate changes to end-user borrowers, the RBI is contemplating using external benchmarks for lending rates. We examine the options available and how such a move could benefit home loan seekers
What is Primary Lending Rate regime
After the deregulation of interest rates following the liberalisation of the economy, banks used to lend at a rate that was benchmarked against their internal rate, which was called the Primary Lending Rate (PLR) and thus, the rate was called Benchmark Primary Lending Rate (BPLR). Under the BPLR regime, the actual rate of interest charged to the customer, was generally at the BPLR or at a discount to the BPLR. The difference between the actual lending rate and the PLR is called ‘spread’. As and when the interest rates increased, your home loan rate would also rise to the extent of increase in the PLR by the banks, so as to maintain the difference between the rate applicable to your home loan and the revised PLR of the bank. Under this system, the borrower was not in a position to ascertain whether he was able to get the best deal, due to the opaque nature of fixing of the rate.
Moreover, banks were quick to raise their PLR, with increase in the interest rate declared by the Reserve Bank of India (RBI) from time to time. However, they were reluctant to reduce their PLR, with reduction in the repo rate declared by the RBI from time to time.
What is Base Rate regime
So, to ensure that the reduction in the repo rate gets reflected in the lending rates and to make the lending rates transparent, the RBI directed all banks to give fresh home loans, on the basis of a rate called the ‘Base Rate’, below which they were not allowed to lend. The banks needed to take into account their cost of funds and expenses, to arrive at the Base Rate. This change in the lending rate, from BPLR to Base Rate, was effective from July 1, 2010.
The Base Rate was supposed to be calculated, with reference to the weighted average cost for the bank. However, the Base Rate system also did not result into passing on of the reduction in the repo rate by the RBI, to the full extent to the consumer, as the weighted cost taken into account for calculating the Base Rate had various cost components of borrowings and deposits with various maturities. Thus, the resultant reduction in the lending rate, would be narrower than the reduction in the Base Rate.
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What is Marginal Cost of Funds-based Lending Rate (MCLR) regime
In order to ensure quick transmission of the reduction in repo rates, the RBI then introduced the concept of Marginal Cost of Funds-based Lending Rate (MCLR), from 2016. Since the MCLR is also based on the borrowing costs of the bank, the inefficiencies of a bank in its operation, would reflect in the form of higher MCLR, as compared to efficient banks.
Instead of benchmarking the lending rate against internal rates like the Base Rate or MCLR, the RBI has now been contemplating the introduction of an independent, market-based benchmark. For this purpose, the RBI appointed an internal study group, to review the operation of the Base Rate and MCLR and to explore the linking of bank lending rates, directly to market-determined benchmarks.
What is external benchmarking for lending rates
The study group submitted its report in September 2017. The committee observed that during the period when repo rates were hiked, the transmission was faster at 60 per cent, whereas, during the period when the repo rates reduced, the transmission was lower at 40 per cent. The group also noted that the methodology to fix the Base Rate and the MCLR were opaque and that banks resort to manipulation, to keep the Base Rate and cost of funds high.
The group recommended that the RBI should mandate banks, to benchmark their lending rates against any of the three – T-Bill rate (treasury bills), the certificates of deposit (CD) rate, or the RBI’s policy repo rate. In order to ensure quicker transmission of changes in the benchmark rates, the group suggested that the resetting clause for interest rates on loans, be shifted from one year to quarterly, for floating rate loans. It also suggested that the spread (difference between the benchmark rate and the actual lending rate) should, generally, remain fixed during the entire tenure of the loan, so as to ensure that the lending rate is not manipulated by the banks to suit their purposes.
How market-based benchmarks will benefit consumers
The study group recommended that the system of independent benchmarking, be implemented from April 1, 2018. While this has not happened yet, the RBI will have to implement the market-driven independent benchmark sooner or later, to ensure transparency and quicker transmission of the rates to retail home loan borrowers.
Without waiting for the RBI to implement the suggestions of the study group, Citibank India has come out with home loans benchmarked against three months’ T-Bills. There are doubts whether Citibank can lend on any other basis, except the base rate and MCLR, although this move is for the benefit of consumers. As and when the benchmarking of lending rates against external benchmarks is implemented, lending rates will become more competitive, as it will remove the cost of operational inefficiencies of a particular lender. It will also bring more transparency to the home loan regime.
(The author is a tax and investment expert, with 35 years’ experience)
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