RBI's rate diktat cuts both ways

If you opt for MCLR, be ready for frequent rise or fall in EMI or tenure

If you have a home, automobile, personal or mortgage loan, you have the option of switching over to Marginal Cost of Funds based Lending Rate (MCLR) from April 1, 2016. Compared to the base rate, the new method will allow faster transmission of changes in policy rates (increase or decrease in repo and reverse repo rates by the Reserve Bank of India) to banks’ lending rates, a more transparent way of rate calculation, according to experts.

Those opting for this should be ready for frequent changes in their equated monthly instalment (EMI) or loan tenure. For example, RBI has cut rate rates four times this year. If banks were to follow suit, EMIs would have come down four times in less than 12 months. However, banks prefer raising or reducing tenure rather than changing the EMI.

The biggest impact will be seen in home loans because these are long-tenure. Loans against property or mortgage loans will also see some impact. The impact on automobile and personal loans will be less, as they are largely fixed-rate loans. These loans are also of shorter tenure of three to seven years. With banks offering home loans for tenures as long as 30 years, in some cases it might not be possible to extend the tenure when the rate goes up. So, borrowers will have to pay higher EMIs.

In the case of hybrid home loans, where rates are partly fixed and partly floating, that on the floating portion should adhere to the MCLR guidelines, according to RBI.

S K V Srinivasan, executive director of IDBI Bank, says the method of calculating will be beneficial to borrowers in a falling rate scenario. However, when interest rates go up, the increase will also be immediately passed on to borrowers.

“Today, banks don’t raise loan rates immediately when interest rates go up. RBI's intention is that transmission of interest rates should happen smoothly,” he says. However, Gaurav Gupta of Myloancare.com, says even if lending rates go up faster, the MCLR is beneficial because it is more transparent. RBI has mandated that banks will review and publish MCLR of different maturities every month, on a pre-announced date. Banks might specify interest reset dates on their floating rate loans. The  dates can be either linked to the date of sanction of the loan/credit limits or the date for review of the MCLR.

This could mean more frequent resets, maybe every quarter. While it could be cumbersome for retail borrowers, the system will eventually get used to it, says Srinivasan.

Today, when RBI cuts repo rates, banks don't cut their lending rates saying their overall cost of funds is still high. However, when RBI increases rates, banks raise their lending rates saying the marginal cost of funds has gone up. That is why RBI has made it mandatory for banks to use the marginal cost of funds to calculate their benchmark rates. “I would recommend borrowers to switch over the new MCLR because it looks like interest rates are likely to stay low in the foreseeable future,” says Gupta.