RBI's external benchmark move: Public sector banks set lower loan rates

A number of banks have met the Reserve Bank of India’s (RBI’s) October 1 deadline and launched loan products linked to external benchmarks. Most have chosen to link their home loan rates to the repo rate. Only Citibank has a product (launched in March 2018) linked to the three-month treasury bill rate.

Public sector banks have priced their external benchmark-linked loans lower than their private sector counterparts (see table).

Customers, who desire greater transparency, should shift to external benchmark-linked loans. “Only customers not comfortable with the higher and more frequent changes in loan rates should consider staying with the marginal cost of funds-based lending rate (MCLR)-linked loan,” says Ratan Chaudhary, head of home loans, Paisabazaar.com.

Adhil Shetty, chief executive officer, BankBazaar, has a different point of view. “Even in a rising interest-rate scenario, customers on an external benchmark-linked loan will know the quantum by which their equated monthly instalments (EMIs) will increase and hence, be able to take measures to minimise the impact. In MCLR-linked loans, there was no clarity about how much transmission would happen.

Old borrowers should compare their current home loans rates with the new ones. “If the principal outstanding is large, shifting makes sense, even if there is just a 25-50-basis point difference in interest rate,” says Aditya Mishra, founder and chief executive officer, SwitchMe, a digital home loan broker. Customers of housing finance companies should consider shifting if bank rates are more attractive.

The banking regulator has introduced tighter rules this time, so that older customers, moving from MCLR-linked loans to the new external benchmark-linked loans, get a fairer deal. Banks have to mandatorily give their older customers the option to shift to their new external benchmark-linked loans. The spread imposed on an older customer has to be similar to that imposed on a new customer with a similar credit profile.

“Banks’ freedom to adjust the spread has been curtailed,” says Deepesh Raghaw, founder, PersonalFinancePlan, a Securities and Exchange Board of India-registered investment advisor. Earlier, when a base rate customer paying a higher interest rate was shifting to MCLR, banks would ask for a fee for shifting him to the lower rate being offered to a new customer. “The RBI’s circular states clearly that banks cannot charge a large fee, only a reasonable administration and legal fee,” adds Raghaw.

State Bank of India (SBI), which withdrew its repo-linked lending rate (RLLR) product, has launched another product linked to a benchmark, which it calls the external benchmark rate (or EBR, linked to the repo rate). The interest rate on a home loan has three components: the external benchmark rate, a spread over the benchmark, and a credit spread (based on the bank’s assessment of the customer’s credit profile).

In SBI’s RLLR-linked product, the split for the best customer was as follows: repo rate (5.40 per cent) + 2.25 per cent (benchmark spread) + 0.40 per cent. The effective home loan rate came to 8.05 per cent. In the EBR-linked product, the split is as follows: 5.40 per cent + 2.65 per cent + 0.15 per cent. The effective home loan rate for the best customer now comes to 8.20 per cent. Thus, the rate at which the best customer can get a home loan from SBI has gone up slightly.  

The RLLR-linked loan had another feature that 3 per cent of the principal had to be repaid every year. In most reducing balance loans, the principal repaid is low and increases with time. In a loan where a constant amount of principal has to be repaid every year, the buyer would have to bear a higher EMI in the initial years. But the advantage of such a product is that the interest cost that the borrower has to bear over the entire loan tenure is lower. Experts Business Standard spoke to said this feature has not been included in SBI’s new EBR-linked home loan.

Finally, personal loans and auto loans were fixed for the tenure of the loan until now. “The nature of these loans will also change, now that they are tied to a dynamic benchmark,” says Shetty.