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Linking base rate to MCLR may not be good enough

Customers should still consider shifting to the best MCLR-linked home loan rate available

Sanjay Kumar Singh 

home loan, house

Home loan borrowers, who had taken loans before April 2016, can expect some relief from April 1. In the Statement on Developmental and Regulatory Policies issued along with the monetary policy statement on February 7, the Reserve Bank of India (RBI) said that it has decided to harmonise the methodology for determining benchmark rates by linking the to the (MCLR) with effect from April 1, 2018. At present, the average difference between the and for banks is around 70 basis points.

The RBI had introduced the regime on April 1, 2016 to overcome the limitations of the The primary issue with the was that banks used it to either not cut their lending rates or to do so after a long lag in response to RBI's rate cuts. An internal committee of the RBI led by Janak Raj had found that both public and private sector banks manipulated calculation, in a manner detrimental to customers’interests.

After the introduction of the MCLR, the RBI had expected that most customers whose home loans were linked to the would migrate to loans linked to the But this did not happen and a considerable number of home loan customers, around 30 per cent, were still on the Hence, the RBI has now decided to harmonise the methodology for determining the with the According to Adhil Shetty, chief executive officer (CEO) and co-founder,, “This ties the scheme to a more responsive system of benchmarking interest rates and will enable a smoother transfer of policy rates.”

What harmonisation means: During the press conference held on the day of the monetary policy, RBI deputy governor NS Vishwanathan emphasised that the central bank is thinking of ‘harmonisation and not equalisation of rates’. According to Naveen Kukreja, CEO and co-founder, “The language of the statement suggests that both the and the will co-exist. However, the computation of the will be linked to the ” Adds Shetty: “Currently it appears that once the is linked to the MCLR, the former will vary in sync with the ” Complete clarity on how the new system will operate will emerge at the end of this week, once the RBI comes out with instructions.

What should you do: A more responsive system of benchmarking interest rates will mean that policy rate changes will reach borrowers on the regime faster. According to experts, one of the following two scenarios is likely. One, the RBI may decide to bring borrowers under the system. This would be welcome news for these customers. This transition would potentially close the gap between the and the interest rates. It can result in significant savings for borrowers, especially those whose loans are less than five years old. Suppose that the principal due on a loan after four years is ~4.5 million for a 20-year loan. The initial rate of interest stood at 9.05 per cent. If it drops by 70 basis points to 8.35 per cent, the customer stands to save ~362,628 in interest cost over the remaining tenure of 16 years

home loan graphic

home loan graphic

However, if the RBI just stops at linking the calculation with the MCLR, customers should first study the correlation between the two rates before deciding what to do next. While the may become more responsive, customers on linked loans could still be paying a higher rate. If the difference between their rate and their bank's MCLR-linked loan rate is considerable and they are only a few years into their loan tenure, they should consider paying the switching fee and shifting to the rate, depending on the saving they stand to make. If their bank doesn't permit this, they should consider transferring their loan to another bank. The final option is to continue on the base rate, especially for customers who are close to the end of their loan tenures.

Lessons for the future: Investors on the regime need to draw a lesson from what has happened. When rates were falling for the past couple of years, they did not take advantage of it by moving to a more responsive benchmark. Now, even if the is linked to the and becomes more responsive, this will happen in a rising rate environment. While their benchmark may respond faster to RBI's rate changes in the future, it is more likely to move up rather than down. They should also bear in mind that rate changes for customers can be passed on immediately while for those whose loans are linked to the one-year it happens only when the time for reset arrives.

The RBI also seems to be giving a quiet burial to the recommendations of the Janak Raj internal committee report, which had said that home loans should move to an external benchmark. Experts say that the adoption of such a transparent benchmark would be a true game changer.

First Published: Mon, February 12 2018. 05:58 IST