Home loans that defy gravity

We know anecdotally that floater rate home mortgages are sticky when they are high and rise quickly when they are low. Therefore, when I got a letter from my home loan vendor telling me that the company had generously reduced the benchmark rate by 0.05% last week, reducing in three digits what I will pay less over the rest of the loan tenor, I was surprised. Over the years, I’ve become used to letters from the home finance company raising rates—sometimes by 25 basis points, sometimes by 50 basis points—making this reduction something unusual. (One basis point is one-hundredth of a percentage point.) I’m stuck (for a variety of reasons) in a home loan that the bank vended, but then passed on to its home finance company. That is a problem because banks now have to use the base rate as a benchmark for all products and not the earlier Benchmark Prime Lending Rate (BPLR). The misuse of BPLR had nudged the Reserve Bank of India (RBI) to force banks to switch over to a base rate system in April 2010. The home finance companies, however, are not obliged to follow the base rate system and continue with home loans pegged to their own BPLR. Blogger Deepak Shenoy has a good piece on this (here: http://mintne.ws/1JJCSxQ ), where he says that some banks pass on their loans to sister home finance companies, thus managing to side-step the base rate-linked loans and staying with a benchmark they fully control. But five years into the base rate system and one full rate cycle later, it seems that even the move to a base rate system has not worked in rate transmission as far are retail borrowers are concerned.

The only example I know of a fair loan is the one that used a third-party benchmark, which worked very well for the borrower. A few months ago I got a mail from a grateful ex-colleague who had just wrapped up his home loan linked to Mibor (Mumbai Interbank Offer Rate—the overnight rate at which banks borrow from each other) and had dropped a line saying thank you for suggesting the product, because over the life of the loan, he paid substantially less than the rest of the market. The Mibor is a benchmark that is not controlled by one bank but is calculated everyday by the National Stock Exchange as a weighted average of lending rates of a group of banks, on funds lent to first-class borrowers. The ex-colleague had been lucky enough to have taken a loan that was offered by ING Vyasa Bank Ltd in 2005 and which linked the interest rate to a Mibor-plus rate.

While there can be arguments about the efficacy of using the Mibor as a benchmark, from the point of view of a borrower, the peg worked very fairly, as compared to a benchmark such as the base rate or the BPLR, which the bank controls. ING Vyasa discontinued the product a year later citing consumer indifference. The real reason possibly was that the loan was not as profitable as the others pegged to less fair rates in the market. And unlike what market fundamentalists believe, competition did not quickly push ther banks to use the Mibor-linked formula. Information asymmetry ensured that not many knew about the loan, leave alone the benefits of taking it.

To see how the base rate behaves in comparison to the Mibor, I called for data starting July 2010 for Mibor and base rates of State Bank of India (SBI), ICICI Bank Ltd and HDFC Bank Ltd. I wanted to see if there was a difference in the way private and public sector banks behaved. I found the base rate behaviour of the three banks almost synchronous, therefore, I’m using the base rate of SBI in comparison with the Mibor in the chart below. It shows that there have been brief moments in time when the base rate was lower than Mibor, but over much longer periods and over much larger spreads, the base rate has been higher. The upward stickiness of the base rate is clear in the chart.

Over 2011, SBI’s base rate went up by 240 basis points to reflect the rising cost of money. Now, in 2015, when the corridor between the base rate and Mibor is at its thickest, the rate cuts are a miserly 30 basis points.

Just looking at the data, two things can happen in the next few months. Mibor rates can rise, reducing the corridor and removing the push for a cut in the base rate. Or, if Mibor rates stay where they are, banks will need to cut the base rate.

Since the introduction of the base rate system, this is the first time that the corridor between Mibor and the base rate is so large. We’re all looking to see if the banks indeed cut it and allow home loans pegged to it to float down.

Monika Halan works in the area of financial literacy and financial intermediation policy and is a certified financial planner. She is editor, Mint Money, Yale World Fellow 2011 and on the board of FPSB India. She can be reached at expenseaccount@livemint.com