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. Why? Well RBI has been disappointed in the way banks were charging interest rate to borrowers. The central bank believed the lenders were not passing on the benefit of policy repo rate to customers. This issue of banks not giving correct interest rates to home, auto, personal loan borrowers is not new to India as RBI, since the time of Raghuram Rajan, has been vocal about the issue. However, banks have remained reluctant and rebellious. But not this time as RBI has vented its fury on lenders and they have been left with no option but to follow this rule. 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. 

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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 external benchmark is not a surprise, as recommendations were made since last year October month. However, banks have debated with this matter and have showed unwillingness to adopt it, but now looks like RBI will have its way no matter what. It needs to be noted that, RBI has been, over the past few months, taking concrete measures strictly to boost banks credit growth and control the rise in stressed assets. 

What is an interest rate? When we deposit money with banks, the authority is liable to pay you interest rate on investments. It is because the banks owe you in this situation as deposits also turn into funds for banks which is latter used for lending. Regarding deposits, it is you, who is the owner of the cash. Similarly, where you earn interest from banks on deposits, you pay interest to lenders when borrowing because this time it is you who owes to the authority and agree to pay an extra sum on the money borrowed. This extra amount is an income to banks hence called as loan interest rates. In lending it is the bank that owns the cash. 

Coming to BPLR, PLR, Base rate and MCLR. Now let’s have an understanding to what they mean to your lending rates currently. 

You all must be wondering why does your interest rates on home loan, vehicle loan and personal loan undergo various changes from time to time. Not just this, there are host of questions like why has my EMIs changed, why is there different interest rate on different tenure, why do you pay a hefty interest then others? These are mere basic questions of every borrowers, however, not many have an understanding to how their interest rate is actually derived by banks. 

Check out how your EMIs will be seen ahead:

To know the answers of above mentioned questions, you need to understand what is MCLR, Base Rate, BPLR and PLR. 

MCLR

The MCLR is the latest one to be developed by RBI which replaced the previous base rate of deciding lending rates. Effective since April 01, 2016, MCLR was supposed to bring transparency in the methodology adopted by a bank for calculating interest rates on home loan, car loan, personal loan, etc. 

Banks decide on their interest rate by adding components to MCLR. These are - marginal cost of funds, Cash Reserve Ratio, operating costs and tenor premium. 

Notably, the marginal cost of fund is calculated on factors like interest rate offered by banks on various deposits such as savings, fixed deposits, current account, foreign currency deposit or short-term interest rate. Also they can be derived from the repo rate on which the RBI lends money to commercial banks. 

Marginal cost of borrowings accounts 92% of marginal cost of fund, while remaining 8% is considered from return on network. Simply put, MCLR is highly decided on marginal cost of funds which takes into account deposits and repo rates. 

Every month, MCLR is reviewed by banks after cumulating the components and published every month on a specific date. Generally it is revealed in the beginning of a month. 

To your knowledge, banks have the liberty to specify dates of interest reset on their floating rate loans. Simply put, a bank can offer loans with a reset dates linked with either to loan sanction date or MCLR review date. However, the periodicity to reset shall be a year or less. 

Also, let’s suppose if the MCLR is currently 9% on the day of loan gets sanctioned, this will continue to exist until the next date of reset regardless of the variations in the benchmark during the period. 

Base Rate 

MCLR was launched because banks failed to pass on the benefits of bare rate. Under this tool, banks were not allowed to lend below the base rate. It was launched to make sure there was increase in transparency in loan markets. A bank decides base rate by taking into consideration factors like cost of deposits, administrative expenses, profitability of a lender in previous financial year and others.

Under Base rate, the cost of deposit has higher weightage, however, banks also have freedom to take this factor in any tenure while computing the base rate. 

BPLR also known as Prime Lending Rates! 

This method was introduced in 2003 also following similar vision of transparency like the above two mentioned benchmarks. However, a bank would offer BPLR interest rate to its most credit worthy customers. 

When this mechanism was in effect, banks had full freedom to set their own BPLR. This benchmark calculated by deriving factors like cost of funds, operational expenses, a minimum margin to meet regulatory requirements of provisioning, capital charge and also profit  margin.  

The issue with this benchmark was that banks were not reducing their BPLR in line with the relaxation made in RBI’s repo rate. 

 By 2010, RBI had realized that there was a need to move beyond BPLR and hence was the introduction of Base rate. 

A bittersweet lesson for banks! 

From the above explanation is quite clear that banks have been lethargic in passing on the benefits of repo rate in borrowers loan interest rates. The release of MCLR from Base Rate and Base Rate from BPLR has most basic core and that was transparency. 

This simply banks have failed to follow so, and the current scenario is such that they now sit on more than Rs 9 lakh crore stressed assets. 

With the privilege of deciding lending rates despite warnings given by RBI, the banks have digged their own grave. This is why, it’s time banks eat their own and make no mistake RBI has a way of making sure lenders follow regulatory pattern. 

Your EMIs to be cheap! Power snatched away from banks 

By asking banks to link with external benchmarks, RBI is trying to make sure that there is no other leverage in hands of bank to decide their interest rates. Why because the benchmark RBI has asked to directly link is policy repo rate, treasury yields and any
other market benchmarks. 

For comparison, a RBI data reveals that weighted average lending rates is currently at 10.36%. Whereas banks have MCLR between 9% to 11% which varies from lender to lenders. 

Further, the base rate stands between 8% to 9%, meanwhile the BPLR of banks are ranging from 14% to 17%. 

These current benchmark are too high, compared to policy repo rate which stands at 6.50%, while treasury yields of 91 days and 182 days ranges from 6.7% to below 7%. This itself proofs the relief in your lending rates ahead. 

Well, how a bank follows this new change in their interest rates will be keenly watched. Has RBI finally managed to take control of loans offered by banks, or these lenders will continue to resist external benchmark in order to book profits. It’s definitely RBI vs
Banks in lending rates! 

However, 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. 

 A loud cheer for Urjit Patel, surely!