While leading banks including SBI, OBC have spearheaded the linking of loan rates to key policy or repo rate, the RBI’s governor Shaktikanta Das now wants the entire banking system to switch to the new regime (linking of lending rates to external benchmark or repo rate) for better, quick and transparent monetary decision transmission to the end consumers. The move once implemented across the banking network will come to the rescue of ailing economy which is seeing slump across sectors.
“I think the time has now come to formalize the linking of the lending rates on new loans to external benchmarks like the repo rate. We are monitoring the developments in this regard and whatever steps are required in the coming weeks, will be taken by RBI”, said Das on the sidelines of the conclave convened by the industry body FICCI and IBA on Monday.
So, how would the transition affect you as a borrower and how does repo-rate linked lending rate (RLLR) loan differs from loans pegged to marginal cost of funds based (MCLR) lending rate is what we will discuss here:
1. Origination of the MCLR versus RLLR based loans:
MCLR or marginal cost of funds based lending rate replaced the earlier base rate system and all of the loans taken post April 1, 2016 were priced as per the bank’s MCLR rate. It is internal benchmark rate of the bank.
Herein in the case of RLLR-based loans, former RBI governor Urjit Patel asked banks to switch to an external benchmark for indexing their new loans both retail and small business loans with floating rates with effect from April 1, 2019. Nonetheless, this decision was widely resisted over various issues by bankers in the system, which led Das to postpone the move.
But after analyzing the response from banks, he now wants to take this process at a much faster rate. And, thus proposes to formalize the linking of loans to repo rate for better monetary decision transmission. Notably, as against the 75 basis point repo rate cut (excluding the latest cut of 35 bps in August ), only 29 bps has been transmitted by banks to its customers.
2. Interest rate on RLLR vs MCLR pegged loans:
Whenever the RBI changes key repo rate, repo-linked interest rate on loan will trend higher or lower accordingly from the 1st of the following month. SBI introduced repo rate linked home loans from July 1 that is based on RLLR (rate currently stands at 8% since July 1). And after the RBI’s repo rate cut of 35 bps in its August 7 monetary policy meet, RLLR will come down in the same proportion to 7.65% from September 1, 2019. So, borrowers get the benefit of rate cut on an immediate basis.
Though, it is to be noted that there is mark-up attached to the RLLR that increases the effective loan rate.
In the case of MCLR-pegged loans, interest rate is indexed to the bank’s cost of funds. And even when the banks reduce their MCLR rate like they did it this time by 5-25 basis points across tenors after the RBI’s repo rate cut of 35 bps in August, existing loan borrowers will not benefit immediately. This is owing to the reset period clause under MCLR which varies from banks to banks. RBI allows a maximum reset period of one-year. So to reap the advantage of the MCLR cut you have to wait until the reset period.
Illustration explaining when the MCLR rate cut is transferred to borrowers: Say you took a home loan from SBI on July 1, 2019 and the bank has revised its MCLR rate lower in August. But despite this your interest rate on loan will continue to be the same until June 30, 2020. And it is only on July 1, 2020 that the MCLR rate cut will be transmitted to you as a reduced interest rate on your borrowing.
In a reducing rate scenario as in the current times, the shorter the reset period the better it is for the borrower. Some of the banks have a reset period of three months also.
So, RLLR will be highly volatile in comparison to the MCLR rate-based retail loan products as for them the banks offer a reset clause of either 3 months, 6 months or a year.
3. Difference in loan repayment method in case of repo-rate linked home loans:
Loan repayment method in case of repo-linked home loan is not the same as a regular home loan EMI payment. Interest is to be paid monthly as and when it becomes due. In addition, a minimum of 3% of the home loan principal amount is to be repaid every year in equated monthly installments (EMI) before the borrower turns 70 years.
4. Repo-linked loans to be cheaper by 25-35 bps:
For borrowers opting for the new repo-rate linked loan products, the benefit will be to the tune of 25-35 basis points. One basis point is one-hundredth of a percentage point. In case of SBI, one-year MCLR as of August 10 stands at 8.25%. So the effective interest rate on SBI’s MCLR linked loan with a floating rate option for loan amount in the range of Rs. 30 lakhs to Rs. 75 lakhs for a salaried class customer works out to be 8-65-8.75%.
And if the same individual chooses the new repo rate linked loan product, the effective interest will be calculated as though: repo rate + 2.25% that makes up repo-linked lending rate (RLLR) and an additional 40 basis point. So, considering July’s RLLR at 8%, effective rate will be 8.4%. And in September, after the latest repo rate cut of 35 basis point is transmitted to the repo-linked products, the effective rate will be 8.05% (5.40% repo rate+2.25% +0.4%).