How RBI's decision on floating rates will give relief to retail borrowers

With the RBI deciding to link all new floating rate loans to an external benchmark, there will be more transparency

Borrowers in the retail and medium-and small-scale enterprises segments should be happy with the Reserve Bank of India’s (RBI) decision to link all new floating rate loans to an external benchmark from April. The decision, say bankers, will impact mostly the home loan segment. Personal loans and car loans are usually fixed rate loans. The MSME segment is likely to be impacted the most. “If bankers follow the external benchmark regulations in its true spirit, retail borrowers stand to benefit,” says a former retail head of a leading bank. 

The external benchmark can be repo rate, 91-day treasury bill, 182-day treasury bill or any other relevant benchmark. “With this move and some other policy decisions, the RBI has ensured that there is liquidity for both retail and MSMEs, but the cost is also determined. The borrowers will also benefit due to transparency, and there will be more trust in the system,” says Ashvin Parekh, managing partner, Ashvin Parekh Advisory Services.  

A new borrower stands to benefit marginally. Say, a bank chooses to link its home loan rate to repo rate, which is at 6.5 per cent. If the spread is at 200 basis points, the borrower will get a home loan at 8.5 per cent. Currently, State Bank of India charges 8.7 per cent – 9.25 per cent while ICICI Bank charges 9 per cent – 9.25 per cent. 

Says Ratan Chaudhary, head of home loan, Paisabazaar.com: “Any change in the linked-benchmark rate will reflect in the lending rates as well. While the banks are free to set the spread over the external benchmark at the time of loan approval, the spread will remain constant throughout the life of the loan unless there is a considerable change in the borrower’s credit profile.  A uniform external benchmark for a particular loan category will ensure transparency, standardisation and ease of understanding for borrowers. Currently, the changes in interest rates for floating rate borrowers differ across banks.”

Though this move won’t impact existing borrowers, customers who have taken long-term home loans recently should watch things carefully. “If there is a difference of 50-100 basis points between existing and new loan rates in April, there can be an opportunity to shift since there is no pre-payment penalty in floating rate loans,” says a former banker. At present, Citibank has a product linked to the external benchmark. The home loan product is benchmarked to the three-month treasury-bill rate. The home loan rate is reset once every quarter on the first of March, June, September, and December.

The RBI and banks have been at loggerheads for decades over monetary transmission. The regulator has said banks move interest rates in such a way that it benefits them. That is, banks have been quick to raise interest rates when the RBI raised policy rates, but were slow to cut when the reverse happened.

The move comes after the apex bank’s internal committee under Janak Raj, principal advisor, monetary policy department recommended the use of external benchmarks for floating rate loans to hasten monetary policy transmission as well as improve transparency in rates by lenders. 

The committee, which was set up to review the working of the Marginal Cost of Funds-based Lending Rate System (MCLR), pointed out banks have treated retail customers extremely shabbily for years. The report studied four major banks (two public and two private) and found that one major public sector bank decided on the MCLR rate based on card rates of retail term deposits of seven days to one year. It fully ignored the current account-saving account or CASA deposits. 

A private sector bank’s base was 80 basis points higher than suggested by the base rate formula in March 2017. Some had even flouted the guidelines of the apex bank by having multiple rates instead of having one MCLR across products.