Home Loans Will be Linked To Market From April 1
With the Reserve Bank of India (RBI) on December 5 directing banks to link lending rates with an external lending benchmark from April 1, home loan borrowers may soon have nothing to complain about the opacity surrounding interest rates.
After maintaining a status quo on key rates in its fifth bi-monthly monetary policy review, the RBI in a separate statement on Wednesday said all new personal, retail and micro and small enterprises loans be linked to one of the four market benchmarks from April 1 next year. Now, banks have the choice to link their lending rate to any of the four benchmarks – repo rate or 92-day or 182-day treasury bill yield or any other external benchmark approved by Financial Benchmarks of India.
The proposal is aimed at ensuring greater transparency in lending rates by banks, the RBI said, adding final guidelines would be issued in this regard later this month.
It begs mentioning here that US-based banking major Citi in March this year launched India’s first market benchmark rate-linked lending home loan product. The bank’s home-loan product is linked to the rate of treasury bills, which is used by the government for its short-term borrowings.
What happened so far?
Currently, banks offer home loans at marginal cost of funds-based lending rate (MCLR). In a scenario where rates are reduced by virtue of the RBI applying a reduction in repo rate – the rate at which the banking regulator lends money to all scheduled banks – only new customers are able to reap the benefits. Unless an old borrower personal contracts and categorically asks it to pass on the benefit, banks feel under no obligation to pass on the benefit to existing home loan borrowers. Banks do not reset the loan till a specific period, as mentioned in the loan agreement, even if the RBI reduced rates several times.
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Even if they actually decide to lower rates because the RBI has goaded them to do so, they use their master tool — spread—to maintain their profit margins while maintaining the legality of their maneuvering at the same time. Even the slightest increase in lending rates, however, is ultimately passed on to the borrowers.
Interestingly, the MCLR regime was launched by the RBI in 2016 to increase transparency in the lending process. Before that, the banking regulator the prime lending rate regime with the base rate regime with a similar intention.
Since attempts to do achieve that failed utterly, the RBI constituted a panel, headed by RBI monetary policy department principal advisor Janak Raj, to suggest ways to improve transparency in the lending process. The panel, which had suggested switching of rates to market-linked benchmark, submitted its report last year.
What changes now?
When lending rates are aligned with market benchmarks, banks will lose all their private capacity to use spread to keep the lending arrangement in their best interest. As a result of this, banks will have to maintain one spread throughout the loan tenure unless a borrower rightfully earns a revision by defaults on loans or becoming a credit risk. After the new regime comes into force, a borrower’s EMI outgo will change as soon as rates go up or down. Tracking your outstanding liability would also become much simpler.