Come April 2019! Borrowers? Your EMIs on home loan, personal loan, vehicle loans set to become cheap; here's how

A new pattern in lending interest rate is set to take place, which is supposed to bring good news and relief to you borrowers. What has happened is that the interest rate on borrowing was linked with a benchmark named as MCLR and now the RBI has decided to remove this hierarchy. A rule which will take away their MCLR benchmark, and not only that every other benchmark as well. Yes, there will be no more MCLR, Base Rate, BPLR and Prime Lending Rate (PLR) for banks, this means your interest rate on loans like home, vehicle and personal is set to change. 

In its December 2018 policy, RBI firmly said Prime Lending Rate (PLR), Benchmark Prime Lending Rate (BPLR), Base rate and Marginal Cost of Funds based Lending Rate (MCLR) will be replaced by an external benchmark from April 2019. 

Now this external benchmark would be RBI Bank of India policy repo rate, or Government of India 91 days Treasury Bill yield produced by the Financial Benchmarks India Private Ltd (FBIL), or Government of India 182 days Treasury Bill yield produced by the FBIL, or any other benchmark market interest rate produced by the FBIL. 

This is how this new rule which is set to take place from April 2019 will impact borrowers and their loans for home, personal and vehicle. 

Kunal Varma - Chief Business Officer & Co-Founder, MoneyTap says, "This move may have mixed effects on the overall lending market - depending on whether we’re talking about unsecured or secured, retail or corporate portfolios.
Over the past 30 years or so, RBI has been trying changing the way lending rates are decided, but there’s been no clear winning strategy."

According to Varma in three ways this new rule will help borrowers. 

1. First of all, Bank’s cost of funds are not anchored today against these external benchmarks. External benchmarks would be benchmarks created from the money markets, govt. treasury bonds/securities yields and forex markets. So once banks anchor their lending rates against these, it will create more transparency in the system partially. However, banks still reserve the right to add their opaque spreads on top of these benchmark rates. This depends on their internal factors.

Consumer-friendly banks and financial institutions may use this to their advantage.

2. Long-term loans such as home loans or asset-backed long tenure loans tend to have floating interest rates, which are more susceptible to change as external benchmarks move in the market. Shorter-term or unsecured loans such as personal loans or auto loans tend to have fixed rates, so these may be more immune to the dynamic nature of external benchmarks.

So the lending rates and corresponding EMI rates for consumers may change or not change as much, depending on the tenures and type of loans (fixed vs. floating).

Shorter tenure products such as personal loans or credit lines with flexible and/or shorter tenures may in general benefit more as compared to longer-term big personal or other term loans, which have more volatility built into the pricing.

3. In general, MCLR for state-run banks tends to be close to almost 9%, whereas external benchmarks such as Treasury yields tend to cap out at around 7.5% or so. Hence there’s going to be a higher spread available for banks if they anchor themselves to these external benchmarks, but not sure if their cost of funds is going down as much. So the financial markets may have resistance in moving to these new benchmarks.

Varma says, "We’ll have to see what benchmark rates are announced by the RBI and FBIL in another month or so, and then we’ll know about the actual potential impact on personal loan rates. Hopefully, we’ll see a neutral stance for the personal loan market; wherein short-term tenures have fixed rates." 

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"As a result, the interest rates may get marginally lowered, and be more immune to market shocks than they were when spreads were built on top of MCLR and PLR based," adds Varma. 

Explaining how the directive is going to impact the market, especially lenders, Aditya Kumar, Founder & CEO Qbera.com said, "benchmarks to fix rates for these big-ticket loans. Using an external benchmark will prompt banks to take measures in line with future volatility estimations, passing on the volatility to consumers. Banks are required to decide a spread value in accordance with the external benchmark, and adjust their rates accordingly within the purview of the spread value."

In Kumar's view, after fixing the rate in line with an external benchmark rate, a bank cannot alter the interest rate for the rest of the loan tenure unless the credit score of the borrower in question changes.

In case of personal loans, Kumar says, "the directive isn’t going to have too much of an impact on the sector as interest rates on personal loans are fixed; floating rates don’t apply to personal loans."

Thereby, one should expect lending interest rates to go down post April, 2019. In other words, your EMIs on home loan, vehicle loan and personal loan will come down going forward.