Each borrower’s loan spread on a new loan above the external benchmark is captured in the loan agreement and is fixed through the loan tenure unless borrower’s credit score changes. Photo: iStock
Each borrower’s loan spread on a new loan above the external benchmark is captured in the loan agreement and is fixed through the loan tenure unless borrower’s credit score changes. Photo: iStock

Transparency vs volatility: Impact of external benchmark for loans

RBI's decision to link bank interest rates for loans against an external benchmark is likely to improve transparency but is also expected to bring volatility. We ask experts how this will impact the borrowers

RBI’s decision to link bank interest rates for loans against an external benchmark is likely to improve transparency but is also expected to bring volatility. We ask experts how this will impact the borrowers

Harjeet Toor, Head – retail, inclusion and rural business, RBL Bank

Harjeet Toor, RBL Bank
Harjeet Toor, RBL Bank

Volatility may have an adverse impact

We will have to see if RBI allows a reset frequency that is different than the tenure of the benchmark that has been chosen as most of these loans are very long tenors of 15 or 20 years. Reset frequencies of 3 or 6 months may not be preferable.

In case of transparency in transmission, it depends on which period of the past we are talking about. Last year, in a reducing interest rate environment, people felt that transmission was not enough. If we look at the last two months, the T-bill rates have been very volatile and gone up sharply while the MCLR’s for banks have not increased as much.

My view is that in a reducing or stable interest rate environment, customers will benefit under the new system. But in a volatile interest rate environment or when liquidity is tight, the movement in these benchmarks is quite sharp, and that may actually have an adverse impact on the customer. Banks’ customers can be assured that the pricing is on an external benchmark, hence transparent. However, about 45% of home loans and 60% of loans against property lie with NBFCs and HFCs. That is still not getting addressed.

Manu Sehgal, Business development leader, emerging markets, Equifax

Manu Sehgal, Equifax
Manu Sehgal, Equifax

Good credit score will get rewarded

In my view, this is a good step that will help in promoting risk-based pricing culture in India. Credit score will become critical for a borrower not only at the point of application, but also during the duration of the loan. At present credit score is critical mainly at the point of application.

The new system will penalize customers whose credit score deteriorates significantly in the duration of the loan. If the score deteriorates significantly, then it can impact the form of increase in the spread on your interest rate, making the loan pricier.

Also, if the system is implemented in the true spirit, this will benefit customers whose credit score improves significantly. They should get the benefit through reduction in the spread on their interest rates, making their loans cheaper.

It is important that customers are rewarded for good credit behaviour and are penalized for poor credit behaviour. Only then will it develop a healthy credit culture and consumers will look forward to that. 

Adhil Shetty, CEO Bankbazaar

Adhil Shetty, Bankbazaar
Adhil Shetty, Bankbazaar

Fix the loan rate reset intervals

Consumers online welcomed the RBI’s proposal to link new floating loan rates post April 1 2019 to external benchmarks. Each borrower’s loan spread on a new loan above the external benchmark is captured in the loan agreement and is fixed through the loan tenure unless borrower’s credit score changes. Credit scores can be tracked online in minutes today. Hence, borrowers have access to information across a range of choice when they sign up for a loan, and will receive rate cuts in an efficient manner over the tenure of their loan. There are currently questions on interest rate volatility. The repo rate resets periodically, and the T-Bill yield is updated daily. Does this mean consumers will have to deal with constant fluctuations? It needn’t be that way. Just as we have in the MCLR regime, the loan rate reset intervals can be fixed at three, six or twelve months. Since information is at borrower’s fingertips, she can evaluate her choices and easily access the right financial product.

Shyam Sekhar chief ideator and founder, iThought

Shyam Sekhar, iThought
Shyam Sekhar, iThought

New benchmark will favour buyers

Currently banks have a price tag approach to giving loans; regardless of the credit worthiness of the client, the rate remains fixed. So after a customer crosses a minimum creditworthiness threshold, she becomes eligible for a loan but the rate at which the loan is given remains the same. Of course, aggressive customers may bag a slightly better rate, but the norm should be that customers with good creditworthiness should be able to get loan at a cheaper rate. We have seen so many our clients with very good credit worthiness but with very poor rates. Bringing in transparency as a result of moving to an external benchmark will change this as banks will take credit worthiness very seriously. This will not only increase the bargaining power of the customers but they will look at their financial standing far more closely. Pegging loan rates to an external benchmark will bring in the required transparency which will tilt the scale in favour of the buyers. For markets to mature, it’s important to empower the buyers. We have seen a similar shift in the case of mutual funds where direct plans have exponentially increased the understanding and awareness.

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