The Reserve Bank of India has issued a circular dated September 4, 2019, making it mandatory for all new floating rate loans from October 1, 2019, to be linked to an external benchmark. This applies to all floating rate retail and MSME loans.
What does this mean for you if you are an existing borrower or plan to take a new loan?
Before we jump on the new announcements, let’s quickly look at the difference between fixed and floating-rate loans. Under a fixed-rate loan, your loan interest rate remains constant for the entire duration of the loan. Under a floating rate loan, you are offered loan at a Benchmark + Spread. As the benchmark (Base Rate, MCLR, RLLR) changes, your loan interest rate also changes.
Back to the RBI circular. Some of the prominent announcements (and what that means) are as follows:
All new floating rate personal or retail loans (housing, auto, etc.) and floating rate loans to Micro and Small Enterprises extended by banks from October 01, 2019 shall be benchmarked to an external benchmark. The banks can choose one of the following as the external benchmark for a loan product.
- RBI Repo Rate
- Government of India 3-Months Treasury Bill yield or 6-months Treasury Bill yield published by the Financial Benchmarks India Private Ltd (FBIL)
- Any other benchmark market interest rate published by the FBIL
What this means?
MCLR will soon be history, at least for the new retail and MSME borrowers.
If your bank is offering you a fixed-rate loan, the external benchmark will not apply.
This is not the first time the banks would launch retail loan products linked to an external benchmark. SBI launched a Repo-rate linked home loan (RLLR) in July 2019. By the way, the banks don’t necessarily have to use Repo-rate as the benchmark. They can use any of the aforementioned benchmarks for their loans. In fact, Citibank launched a home loan product linked to 3-month Treasury Bill rate a couple of years back.
The linkage to external benchmarks shall only apply to banks. As of now, Housing Finance Companies (HDFC, LIC Housing Finance etc) are excluded from this rule and don’t have to link their loans to external benchmarks.
What about the existing borrowers on Base Rate or MCLR?
Existing loans linked to Base Rate/MCLR/BPLR can be continued without any change until maturity. The bank cannot force you to switch to the external benchmark.
If you have a floating rate loan where there is no prepayment penalty, you can request your bank to link your loan interest rate to an external benchmark. Note “Floating Rate” and “No prepayment penalty”. Most home loans will fall under this category.
As for the charges for such a switch, RBI says that such a switch shall be allowed without any charges/fees, except reasonable administrative/ legal costs. As I understand, there shouldn’t be any significant charges for switching. We will see how the banks will interpret it or if there are any loopholes in such a statement.
What will be the rate of interest after the switch? Should you switch?
RBI circular further mentions (for switch cases) that The final rate charged to this category of borrowers, post switchover to external benchmark, shall be same as the rate charged for a new loan of the same category, type, tenor and amount, at the time of origination of the loan.
As I understand, if you are switching, you would get a rate that a new borrower would get.
When borrowers switched from Base Rate to MCLR, there were given two options:
- Switch to MCLR while keeping the rate constant without paying any fee. Essentially, the bank would tinker with the spread and keep you on the same rate of interest. Any benefit will accrue due to changes in MCLR in the future. So, if your loan interest rate under base rate was 9% and MCLR was 8.5%, your spread would be 0.5%. If your loan interest rate was 9.25%, the spread for you will be 0.75%.
- Switch to a lower rate (that a new borrower with your credit profile would get) by paying a fee. This made calculations quite complicated for many borrowers. They had to do a complex cost-benefit analysis.
As I understand, now you will have an option to switch to a lower rate (that a new borrower with your credit profile would get) without paying any fee. Essentially, the bank will not be able to tinker with the spread just to keep the interest rate constant. Or so I think. The banks typically find out a way. A good move by RBI. You can simply compare the existing and the new interest rates and decide.
Other Points to Note
The interest rate under the loans linked to an external benchmark will be reset at least once in 3 months. This means your loan interest rate will change/reset every 3 months or less. This is again to effect quick transmission. Many MCLR loans had reset period of up to 1 year. By the way, SBI Repo rate linked home loan has a reset period of 1 month (interest rate can change every month).
A bank must adopt a uniform external benchmark within a loan category. In other words, the adoption of multiple benchmarks by the same bank is not allowed within a loan category. For example, a bank can’t have a few home loans linked to repo rates while the others are linked to 6-month treasury yields. A good move again.
About the spread on these loans, the banks are free to choose the spread over the external benchmark. The spread can change if your credit profile undergoes a significant change. There is provision to change spread due to increase in operating costs once in 3 years.
The banks are free to offer such external benchmark linked loans to other types of borrowers as well. If the banks wish, they can extend this rule to corporate borrowers too. Not that you should care.
What to expect? What should you do?
Now that the deadline is only a few months away, there will be a rush to launch home loan products linked to external benchmarks.
From the borrower perspective, this move brings in more transparency. When things are not transparent, the more resourceful party (the bank) is likely to benefit at your expense (the weaker party). Therefore, it is clearly a good move from a borrower’s perspective. The externally benchmarked loans can be quite volatile since both rate cuts and hikes will be passed on quickly. However, given how the banks work, you are better off in a more transparent regime.
From the banks’ perspective, I am not very sure. RBI, in December 2018, had mandated that all new loans from April 1, 2019, had to be linked to external benchmarks. The move was put on the back burner due to banks’ resistance and now it has been brought back. The banks have issues with external benchmarks and some of them are justified too. The liabilities (deposit interest rates) are not linked to external benchmarks. Moreover, the deposit rates compete with other products such as small savings schemes (that do not really move with market interest rates). We will have to see how this affects the banks’ interest margin and performance. For now, linkage to external benchmarks is only for retail and MSME loans.
Do note only banks are required to link new loans from October 1, 2019, to external benchmarks such as Repo rate. Housing Finance Companies (HFCs) such as HDFC are not required to link to external benchmarks. Therefore, if you are planning to take a new loan, explore your options with the banks first. You will not get such transparency in the interest rate from the Housing Finance Companies. If you have an existing loan from an HFC, consider shifting your loan to a bank. Easier said than done but clearly worth a shot.
11 thoughts on “Home Loans from October 1, 2019, to be linked to External Benchmark”
You have suggested existing a Housing Loan Borrower should shift from HFC, like HDFC Limited, to some Bank. Not sure whether such a move would benefit him.
Further, HFCs and NBFCs are not required to link their Lending Interest Rate to the External Benchmark, like, RBI Repo Rate, Government of India 3-Months’ / 6-Months’ Treasury Bill Yield, etc. However, they are not barred from adopting the New Base to be effective from 01.10.2019. So, if they adopt the New Base, Borrower of an HFC or an NBFC may stick to it.
Your feedback would be highly appreciated.
Hi Chandravijay,
I agree with you. If they link to the new benchmark, there is no difference.
However, it is not so easy. The cost structures of an NBFC are very different. At the same time, they have lesser restrictions too.
We will have to wait and see.
With bulk of the rate cuts done (only another 40 bps expected from RBI), banks are now asked to adopt to external benchmarks. They will do so by fixing a spread that will protect their interests. It will be beneficial in a big way to them when rates go up. I guess there wont be much of a benefit for customers except for some short term joy because these rates will be slightly lower than MCLR rates.
On the other hand, history says that banks abandon revision of older benchmarks once they are discontinued. They did that to Base rate after MCLR was introduced. So MCLR will not be reduced any further even if external benchmarks based rates go down. Of course they will raise MCLR if rates go up.
I can see only one winner here, They are the banks. They lose to Mallyas and Modis but always win against those who pay monthly EMIs.
Hi Pradeep,
I agree that the banks try to figure out loopholes.
Deepesh
I hope you saw what SBI did in the last week. They simply rolled back their RLLR home loan and re-introduced it with higher rates. The rates for loans under 30L are below
Earlier announced Rate = Repo Rate + 2.25% + 0.4% to 0.55%
So that was 5.4% + 2.25% + 0.4% = 8.05% to 8.2%
New Rate = Repo Rate + 2.65% + 0.15%
So it has become 5.4% + 2.65% + 0.1% = 8.2%
The spread has been increased from 2.25% to 2.65%.
For loans above 30L, the new rate is a whopping 8.4%.
MCLR = 8.15%!!!
All of this after aggressive rate cuts by RBI and so much noise about no transmission.
Funnily the TV anchor asked SBI MD that they will see the rates go down by another 0.25% due to another rate cut in Oct by RBI, is it okay for SBI?
I think the RBI governor is saying one thing outside and secretly asking banks to increase the rates to cover for their bad loans.
And these people got tax bonanza as well.
I bet in 5 years times the home loan rates will be nearly 15%.
All the best to all how loan takers.
Hmmm…this is bad.
When I read this news first, my mind went back to your previous comment.
Let’s see how it goes.
If they keep changing spread over Repo rate in RLLR itself (by withdrawing the products), it is a big problem.
You see if RBI had forced these banks to link their rates to Repo Rate in April (at the start of rate cut cycle) when it was more than 6.25%, borrowers would have got a better deal. Banks may have fixed their spread at 2.5% or so.
Now RBI has cut the rates to historic lows and belatedly forcing banks to introduce such rates.
Banks are fixing it at high level of spread. So when Repo rates goes back upto say 6.5% we could see the interest rates for these borrowers at 10%.
Urjit Patel had set the deadline to introduce the Repo linked rates by April which the current governor relaxed. Knowing where he came from, we should not be surprised at his decisions..
MCLR based loans were only about 9% when Repo Rate was 6.5% in Jan this year.
See the level of fraud that is underway. I hope nobody buys home for few years, if they do they will be defrauded and doomed by RBI and banks.
I will not switch to this rate from my MCLR based rates even if I had to pay more currently.
Hi Deepesh,
Is there a way to check that how my auto loan rate is linked to … i mean is it MCLR or something else & what is it’s reset period. I bought the car loan in feb 2019 & is it worth shifting to external benchmark.
Hi Nitin,
The information will be there in your loan document. You may find this information on the net banking portal too.
I took homeloan (Base Rate) of Rs. 20 Lakh in March 2015 at 9.65 interest rate. Now I want to shift it RLLR.
– Current RLLR rate for IDBI is 7 to 8%
– Also charging Rs. 5900 for the shift.
– Spread will depend upon my credit score.
– But it is said that only one time shift of Base rate to RLLR is possible, later it can not be re-shift to base rate.
– Is it good move to shift to RLLR?
Additional Info:
Outstanding Loan Amount: 17, 00000
Total Tenure: 20 years