All Indian banks have switched to the external benchmarks mandated by the RBI (Reserve Bank of India) for home loan pricing. Most banks have adopted a conservative approach towards this shift although retail customers will naturally benefit more from availing loans tied to an external benchmark.
In the present scenario, you should play your cards right if you want to maximize your overall benefits. Most borrowers have always frowned upon the propensity of lending institutions to jack up rates of interest in sync with the policy rate increases at RBI and their tendency to go slow on rate cuts even when the RBI cut the policy rates. Existing borrowers also witnessed scenarios where new borrowers were being offered lower rates while they were still stuck at higher interest rates. The PLR (Prime Lending Rate), Base Rate, BPLR (Benchmark Prime Lending Rate) and MCLR (Marginal Cost of Funds Based Lending Rate) have not changed the scenario drastically.
Why an external benchmark was the need of the hour
Banks have sometimes highlighted their internal cost of funds being the major reason behind the slow transmission of policy rate cuts. As per studies, RBI has lowered policy rates by 110 basis points this year between February and August although banks have lowered interest rates by only 29 basis points in comparison. The RBI has already taken note of this fact in its review meeting on the 4th of October, 2019.
RBI has directed banks to shift to an external benchmark for loan pricing from the 1st of October, 2019, onwards. RBI allows banks to select from the 3/6 month treasury bills, repo rate or any other benchmark market interest rate which is published by the FBIL. Most banking institutions have selected the repo rate as the external benchmark. The treasury bill linked rates may have higher volatility levels and may be driven by the market. The repo rate is also something about which people are more aware about.
Key aspects worth noting
- The effective rate of interest will be the repo rate + the spread chosen by the bank which is negative carry on CRR + operating cost + credit risk premium.
- Banks will be resetting rates every 3 months.
- Credit risk premium may change in case of a change in credit assessment of borrowers as per the loan agreement.
- SBI, for instance, charges a 265 point spread over the 5.4% repo rate for loans up to Rs. 30 lakh. A credit risk premium of 15 basis points comes into the picture for customers who have superior internal risk grades. This can be spread till 75 basis points based on factors like the amount of the loan, income source and internal risk grading.
- Women borrowers will get a cut of 5 basis points on rates of interest.
- Borrowers naturally have to face risks of interest and EMI increasing in case of a shift in the cycle of policy rates.
- Choose a bank which charges the narrowest possible spread over and above the repo rate. The rate of interest will be closer to the benchmark rate then.
- The credit risk premium has been revealed by some banks like Union Bank of India, SBI and Syndicate Bank while some banks like ICICI Bank, Citibank and Axis Bank have not done so yet. Union Bank and Syndicate have chosen the CIBIL score for working out risk.
- You should enquire about this, prior to signing the loan agreement.
- Analyse how the risk score is being worked out. Seek banks where rates of interest are linked in a transparent manner to credit scores.
- Apply with a festive offer on processing fees which may be waived or discounted in order to save more.
- Switch to an external benchmark in a timely manner from Base Rate or MCLR linked loan products.
- Check the charges involved in refinancing of your loan including insurance premiums, fees for lawyers, stamp duties and so on.
- Choose a conversion to the existing bank’s repo rate linked product if possible for a simpler process.
- Analyse the costs accordingly and wait till your bank releases details of the credit risk premium and the mechanism/clauses behind resetting of interest rates.
- Consider the difference between the new interest rate (benchmarked to the repo rate/external benchmark) and the one you are paying at the moment.
- Switch to the new rate in case the gap between the two is a minimum of 35 basis points.