If you are planning to take a floating rate loan from a bank after 1 October, the interest rate you’ll pay will be linked to an external benchmark instead of the earlier marginal cost of funds-based lending rate (MCLR). To facilitate better transmission of policy rates, the Reserve Bank of India has mandated all banks to link all new floating rate loans to an external benchmark such as repo rate, three-month or six-month treasury bill yield, or any other benchmark published by the Financial Benchmarks India Pvt. Ltd, from 1 October 2019.
According to Adhil Shetty, CEO, BankBazaar, this is a great move for borrowers. “With interest rates falling regularly, a repo-linked loan will work to the borrowers’ advantage. In the past, they got the full brunt of rate hikes but rarely the full benefit of rate cuts. Repo-linked loans should put an end to this," he said.
New bank borrowers
In a circular issued on 4 September, RBI said that while it mandated external benchmark-linked lending rates to be applicable for new floating rate personal or retail loans and floating rate loans to MSMEs, banks were also free to offer such external benchmark-linked loans to other types of borrowers. Several banks, including State Bank of India, Bank of Baroda and Oriental Bank of Commerce, have already launched repo-linked lending rate (RLLR) products.
Banks have also been asked to reset interest rates under external benchmark at least once in three months. Under the MCLR system, even if banks were to cut rates, there was a reset clause, which meant that there could be a lag in your home loan rate being changed even if the MCLR changed, because the reset period could be as long as a year. But, in the case of an external benchmark-linked rate, your interest rate will be reset within three months of a rate cut.
The circular further said that while banks are free to decide the spread over the external benchmark, the credit risk premium may undergo change only when the borrower’s credit assessment undergoes a substantial change. But according to Gaurav Gupta, founder and CEO, MyLoanCare, an online non-banking finance company (NBFC), there is lack of clarity about some aspects of the move, spread being one of them. “RBI should clarify that once a spread has been fixed over an external benchmark, it should not change for the longevity of the loan. The current wording is not very clear. Under some heads the banks might have the flexibility to increase the spread, which would defeat the purpose of the move," he said.
For existing borrowers, the change is slightly more complicated. “A change from MCLR to the benchmark-linked rate will not happen automatically for existing customers. The loan agreement is applicable for the entire tenor of the loan. So you will need to approach your bank and ask to be switched," said Shetty.
According to the circular, for loans where there is no prepayment penalty, the borrower can switch to the benchmark-based lending rate without any additional charges except “administrative and legal costs". Prepayment is a facility to repay your housing loan partially or in full, before the end of the tenure. But since it also means forgoing on interest rate payment, the lender charges a prepayment penalty. While this technically exempts all floating rate home loans, which do not have prepayment penalty, according to Gupta, this is contradicted by the circular, which states that “existing loans and credit limits linked to MCLR/base rate/BPLR shall continue till repayment or renewal". He said that there is no clarity about what administrative and legal charges entail, so it’s hard to tell what existing borrowers would have to pay to switch over to a benchmark-linked rate. “Such a move should not count as a re-booking of a loan, because if it does, stamp duty would have to be paid again," Gupta added.
For other borrowers, the option to move to an external benchmark will be available on the basis of their agreement with the bank.
Beyond the banks
It may be noted that those who have borrowed from NBFCs like housing finance companies (HFCs), which hold a large portion of the mortgage market, are not covered. “Almost 40% of the home loan market is with NBFCs and HFCs. There is no clarity on whether this regulation would extend to them. Ideally, there shouldn’t be two benchmarks in the same market. It would be prudent for the regulator to bring NBFCs and HFCs into the ambit of the regulation," said Gupta.
So should borrowers from NBFCs and HFCs switch to a bank? That depends on whether the benefit of the benchmark-linked rate outweighs the charges and penalties that will be incurred for the switch. “While it definitely makes sense for borrowers to choose banks for their housing finance needs - as the benefits of rate cuts will now be passed on to them more effectively, it isn’t unjustified to approach NBFCs like HFCs. Many a times, borrowers with average credit health who fail to get approved by top banks qualify for loans from HFCs," said Aditya Kumar, founder and CEO Qbera.com, a fintech lending company.
The move is a welcome change, and can give the much-needed leg-up to the retail lending space, which could, in turn, boost consumption. But the notification still lacks clarity on some aspects.