Taking a loan? Rates to now be linked to external benchmark

MUMBAI: In a bid to bring transparency into loan pricing, the Reserve Bank of India (RBI) on Wednesday said all banks will have to link floating rate loans to external benchmark rate and do away with marginal cost of funds based lending rate (MCLR).

From April 1, 2016, all new floating rates for home loans, personal loans and auto loans will be benchmarked to repo rate, 91-day treasury bills yield produced by the Financial Benchmarks India Pvt. Ltd (FBIL), 182-day treasury bill yield produced by the FBIL or any other benchmark market interest rate produced by the FBIL. According to the central bank, the spread over the benchmark rate—to be decided wholly at banks’ discretion at the inception of the loan—should remain unchanged through the life of the loan, unless the borrower’s credit assessment under goes a substantial change.

“So far banks used internal benchmark to calculate and set home loan rates. Now RBI is asking banks to pick external benchmark rate plus a spread as the rate for borrowers. So if the external benchmark rate is 6% and the spread is set at 250 basis points (bps), the home loan rate will be 8.5%. If the external benchmark rate changes to 5%, then your home loan rate will change to 7.5%. The spread can’t change for the lifetime of the loan. But if the credit profile of the customer improves, the bank can reduce the spread from say 250 bps to 225 bps,” said Rajiv Anand, executive director at Axis Bank Ltd.

The RBI has also asked banks to adopt a uniform external benchmark within a loan category. “Banks will have to decide on which external benchmark rate it wants to link loans as there are multiple options available. We will study the various options available,” said Anand. Simply put, the adoption of multiple benchmarks by the same bank is not allowed within a loan category. RBI will issue final guidelines by the end of December 2018.

In the past, RBI has pointed out that the banks are not passing the benefits of lower interest rates to consumers and in the last 7 years, floating rate home loans have switched from benchmark prime lending rate (BPLR) to base rate in 2010 and then to marginal MCLR in 2016. The latest move is to ensure that the banks don’t withhold the benefit.

However, it will make loan rates more volatile. “As banks use external benchmark, there is going to be greater level of transparency but you will also see volatility in the home loan rates. It also means customers will have to bring in more discipline in managing their cash flow for paying EMIs,” said Anand.