Experts give thumbs up to linking home loans to external benchmarks

With all banks mandated by the Reserve Bank of India (RBI) to link their retail loans to an external benchmark from October 1, interest rates on home and auto loans are expected to decline from next month. When some public sector banks (PSBs) shifted their benchmarks to the repo rate in September, their new loan offers were priced at least 20 basis points (bps) cheaper.

The State Bank of India, for example, offers the lowest repo-linked home loan rate at 8.05 per cent. The bank’s home loan based on the marginal cost of funds-based lending rate (MCLR) is 30 bps higher at 8.35 per cent. The interest rate difference for Punjab National Bank’s home loans is 25 bps.

The difference is more pronounced in auto loans. Indian Bank’s auto loan based on MCLR, for example, is 9.45 per cent, whereas the one linked to the repo rate is 8.85 per cent — a difference of 60 bps. “The downward revision of interest rates on fresh loans is not only due to the change in benchmark. Banks had earlier not transmitted the RBI’s rate cuts. That is happening now as they shift to a new benchmark,” says Gaurav Gupta, founder and chief executive officer (CEO), MyLoanCare.

The RBI governor had also said that the transmission of policy rates at just 29 bps this year compared to a combined repo rate cut of 75 bps (excluding the 35 bps cut in August) did not meet the regulator’s expectations. It, therefore, mandated all banks to shift their retail loans and also loans to micro, medium and small enterprises (MSMEs) to an external benchmark, starting from October 1. It has specified a few external benchmarks, including repo rate, three-month and six-month treasury bill yields published by Financial Benchmarks India (FBIL), or any other benchmark market interest rate published by FBIL.

The regulator has also said that banks should allow existing borrowers on floating rate loans to move to the new benchmark free of cost. Lenders can, however, charge a ‘reasonable’ administration or legal fee for the switch. Banks usually offer three categories of loans on floating rates — home loans, auto loans, and loans against property.

Banking experts say loans linked to external benchmarks are more transparent. Banks can’t control the setting of an external benchmark. The transmission is faster when the regulator cuts or hikes rates. “The grouse borrowers have had is that their home loan rates don’t fall quickly when the RBI cuts policy rates, but they rise quickly whenever the central bank raises the repo rate. This concern will get addressed with a loan linked to an external benchmark,” says Aditya Mishra, founder and CEO, SwitchMe, a digital home loan broker. To ensure that transmission is within a specified time frame, the RBI has said “the interest rate under external benchmark shall be reset at least once in three months”.

The current regulations cover banks only. The RBI, which is now the regulator for housing finance companies (HFCs), too, has not announced the same rules for them. Opinion is divided on whether HFCs and non-banking financial companies (NBFCs) will be made to follow the same regime. Banking experts say their cost of borrowing is higher and the regulator would, therefore, let them decide their benchmark.

If you are an existing borrower with an HFC or an NBFC, there will be considerable rate difference between your existing rate and what banks will offer on these external benchmark-linked loans. Consider shifting to a bank to avail the benefit of lower rates. If the remaining home loan tenure is over 10 years, a difference of over 25 bps can result in significant savings. Use online calculators to see how much you can save if you shift and then take a call accordingly.