Must Knows

RBI directs banks to link retail loans with external benchmarks

[] The RBI has made it mandatory for banks to link all new floating-rate loans for housing, auto and MSMEs to external benchmark like repo rate from October 1

September 5, 2019: The RBI has made it mandatory for banks to link all new floating-rate loans for housing, auto and MSMEs to external benchmark like repo rate from October 1, a move aimed at ensuring faster transmission of policy rate cuts to borrowers.

You are reading: RBI directs banks to link retail loans with external benchmarks

Industry and retail borrowers have been complaining that banks do not pass on the entire RBI’s policy rate (repo rate) reduction to them.

In a circular issued on Wednesday, the Reserve Bank of India (RBI) said it has been observed that due to various reasons, the transmission of policy rate changes to the lending rate of banks under the current marginal cost of funds based lending rate (MCLR) framework has not been satisfactory. Therefore, it has now decided to make it “mandatory for banks to link all new floating rate personal or retail loans and floating rate loans to MSMEs (micro, small and medium enterprises) to an external benchmark effective October 1, 2019”, the circular said.

In 2019, the Reserve Bank has already reduced the repo or short-term lending rate by 110 basis points, but the banks have reportedly passed on only up to 40 bps to borrowers.

The external benchmarks, to which the banks will be required to link their lending rates, could be repo, 3-month or 6-month treasury bill yield, or any other benchmark published by the Financial Benchmarks India Private Ltd (FBIL).

The banks have also been asked to reset the interest rate under external benchmark at least once in three months.

“In order to ensure transparency, standardisation, and ease of understanding of loan products by borrowers, a bank must adopt a uniform external benchmark within a loan category; in other words, the adoption of multiple benchmarks by the same bank is not allowed within a loan category,” the RBI added.

The circular further said while the banks are free to decide the spread over the external benchmark, the credit risk premium “may undergo change only” when borrower’s credit assessment undergoes a substantial change.

Further, other components of spread including operating cost could be altered once in three years.

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Existing loans and credit limits linked to the MCLR/Base Rate/BPLR shall continue till repayment or renewal, as the case may be.

The decision of the RBI assumes significance amid clamour for reducing borrowing cost to push consumer demand, which is one of the major reasons for slowdown in the economy.

High-frequency indicators like a significant drop in auto sales and other consumer non-durable are pointing towards demand slowdown. The government has announced a slew of measures like liquidity support to the NBFC sector to further push credit disbursal.

The RBI had earlier asked the banks to link the rates to external benchmark from April 1, but it was deferred as the lenders wanted more time. The State Bank of India had become the first bank to link its certain loans to repo. Later, a host of other banks too started linking their loan products to repo or other external benchmarks.

In August 2017, the RBI had constituted an Internal Study Group (ISG) to examine the working of the MCLR system that was put in place in April 2016.

The ISG had recommended the move over to an external benchmark based lending rate system.

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Repo rate-linked lending rates: Will it make home loans more transparent?

Reserve Bank of India (RBI) governor Shaktikanta Das, on August 19, 2019, said that the time had come, to formalise linking of lending rates with external benchmarks such as the repo rate and directed banks to ensure greater and faster transmission of changes in monetary policy rates. “We are monitoring the developments in this regard and whatever steps are required, in the coming weeks, the RBI will be initiating,” Das said.

The RBI directive comes at a time when several public lenders, including State Bank of India (SBI), have already announced plans to link their home loans rates with the repo rate, the rate at which banks borrow money from the banking regulator. Among other financial institutions that have unveiled their plans to link their home loans to the repo rate are Syndicate Bank, Bank of India, Bank of Baroda, Union Bank, Indian Bank and Allahabad Bank.

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Repo rate-linked lending rates: Benefits for home loan borrowers

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Repo-linked lending rates (RLLR) are likely to make borrowing, especially for home loan seekers who spend a large part of their working life in repaying their liability, more transparent than it currently is. As it stands now, banks use internal lending benchmarks ─ such as the marginal cost of funds-based lending rate (MCLR), retail cost of funds-based lending rate, base rate, or benchmark prime lending rate ─ while issuing loans. While the rates set by the RBI act as a guiding force, financial institutions are free to set rates as high or as low as they deem fit, according to their internal workings and this typically takes into consideration deposit rates, the cost of sourcing funds, etc.

[] With banks increasing MCLR rates, what should home loan borrowers do?

Consequently, banks are quite slow when it comes to passing on the benefits in a scenario of falling interest rates, while they respond quickly in case of an increase. In 2019, while the RBI has reduced the repo rate by 75 basis points (bps), banks have responded with only a 35 bps reduction in their lending rates, on an average. The RBI’s monetary policy committee (MPC) meets every two months, to decide on interest rate changes. When home loans rates are linked to the repo rate, any increase or decrease in the same, is likely to be transmitted faster to loan borrowers.


Factors to consider, while opting for repo-linked lending rates

Available only on floating rates: The RLLR will only be available, if you take a loan on floating interest rates. New borrowers should note that if they decide to go with a fixed rate of interest, they would not be able to avail of the RLLR regime. Banks typically work out a higher interest rate for fixed rate home loans.

Repo rate to serve as a benchmark, while the actual rate would be higher: While the repo rate would be a benchmark, banks will charge a higher interest to maintain profit margins, by way of increasing or decreasing their spread. For example, as against the current repo rate of 5.4%, Bank of Baroda will levy an 8.35% interest on repo rate-linked home loans. If this is any indication, the difference between the repo rate and RLLR could be in the range of 300 bps or more.


Should home loan borrowers switch to the RLLR?

Experts are of the opinion that switching to the new regime is a more viable option for home loan seekers. “With repo rate-linked home loans, borrowers can expect a much faster transmission on to their loan rates. Also, such loans will be more transparent, as far as the rate-setting mechanism is concerned and should provide more clarity in calculating interest rates,” says chief executive officer and co-founder, Naveen Kukreja.

In case of RLLR, borrowers will also be in a better position to compare the rates offered by different banks and make a wise choice. While new borrowers will have the option to pick between the MCLR and RRLR, existing borrowers who wish to go switch to the new benchmark will have to get in touch with their home branch, to get the work done.

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Category: Must Knows

Debora Berti

Università degli Studi di Firenze, IT

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