In welcome news for home loan borrowers, from April 2019, as per the directive issued by the Reserve Bank of India (RBI), home loan pricing will be based on markets instead of the banks themselves. Banks will have to compulsorily link all floating interest rate loans for individuals and small businesses to external benchmarks. This could be the repo rate of the RBI or the 91/181 day treasury bill yield or any other benchmark in the Financial Benchmarks of India.
The RBI has stated that this move will boost overall transparency when it comes to home loans and other loans linked to floating rates. The first step was shifting towards the MCLR from base rate. To further the movement towards more transparency for customers, banks will now have to link all SME and personal loans post April 2019. The actual loan cost will be the benchmark and spread and the latter will remain constant throughout the loan tenor unless the borrower’s credit worthiness changes.
At present, Citibank is the only financial institution using an external benchmark to determine home loan pricing. In March 2018, Citibank unveiled its home loan offer where rates of interest were tied to the 91 day treasury bill of the Government. An external benchmark will also enable better and swifter transmission of the latest rates for loans. Banks have historically attempted to safeguard their own margins by not lowering rates equally at times of rate cuts by the RBI or in growth phases. This switch to an external benchmark was proposed first by a committee that was spearheaded by the RBI’s monetary policy department’s principal advisor, Janak Raj.
The RBI has been attempting to tackle the floating rate loan issue for many years now. The issue is that loan rates move up quickly with rises in market rates but they do not come down as much when rates of interest come down in the market. Banks have managed to keep the rates varied for customers through varying of the spread at which they provide loans. The shift to MCLR has not quite solved this problem and hence the decision of the RBI that will be implemented from April next year.