Home loan borrowers can now rejoice as the Reserve Bank of India (RBI) on December 5 in its fifth bi-monthly policy meet proposed that floating rate home loans will now be benchmarked against an external benchmark from April 1, 2019. This is expected to enhance the transparency for the home loan customers.
RBI has suggested the use of external benchmarks such as the repo rate, 91-day Treasury bill yield or the 182-day Treasury bill yield produced by Financial Benchmarks India (FBIL). The RBI has also allowed banks to choose any other benchmark market interest rate produced by FBIL.
This comes as a big respite to home loan borrowers, many of whom have perennially complained that the banks were quick to raise the rate of interest when the rates in the economy were going up but were slow to reduce the rate of interest on home loans. Further, over the years, different methods were used to fix the loan rates and how they were to move over time, in line with rising and falling rates in the economy, such as prime lending rate, bank prime lending rate (BPLR) and marginal cost of lending rate (MCLR) in the past. All these benchmarks were internal to the bank and experts say that neither pro-actively passed on the benefits to the customers.
To overcome the situation, the regulator brought in MCLR-based products in April 2016. An MCLR linked home loan product would have three component to it. Let’s understand this with an example. MCLR 6 months + 0.4%. Here the bank used to mention its MCLR – says 8.6%. 0.4% used to be the spread to be charged over the MCLR. That would mean that in the above case the applicable rate of interest would be (8.6% + 0.4% =) 9%. And in the above case, the rate used to get revised every six months. At the time of getting a home loan, a client is expected to know all three factors – MCLR, the spread and the frequency of the revision.
Sukanya Kumar, Founder of RetailLending.com, a home loan advisory firm, said: “Though home loan is the largest loan most individuals ever take in their lifetime, they rarely spend the time to understand how their home loans work. Not all customers shifted from BPLR to MCLR system quickly which was better than the previous arrangements due to want of understanding of the home loan products.”
An internal study group set up by RBI and headed by Janak Raj, principal adviser, monetary policy department, had observed that quite a sizeable part of the bank loan portfolio continues to be at the base rate and some even at BPLR, which has also hampered monetary transmission. In simple words, the committee noted that banks didn’t entirely pass on the benefits of rate cuts to home loan borrowers. In addition to the benchmarks for floating rate home loans mentioned above the group also recommended the periodicity of resetting the interest rates by banks on all floating rate loans, retail as well as corporate, be reduced from once in a year to once in a quarter to expedite the pass-through from the monetary policy signals to actual lending rates. The RBI has now accepted these recommendations for retail consumer and small and medium firms.
Putting an end to the confusion of multiple benchmarks, the RBI policy statement has made it clear that the banks cannot offer multiple benchmark for their loan products in one category going forward. Existing products based on PLR, BPLR and MCLR will soon become history. This will lead to standardisation of the home loan products and customers will find it easy to understand the products and pick one that suits their needs.
To be sure, Citibank already has a home loan product that charges interest at the rate linked to treasury bill benchmark linked lending rate (TBLR). The TBLR is reset quarterly.
In the new regime the benchmark being external, the banks won’t control the rates at their advantage. The customers can effectively compare the offers across lenders and ascertain which banks they want to go to.
Though the new system of external benchmarks mean effective transmission of interest rates, it also means that the home loans will be priced taking into account market forces. As per the new recommendations, the spread will be ascertained at the time of disbursement of loan and can be changed only if borrower’s credit assessment undergoes a substantial change and as agreed upon in the loan contract.
A missed credit card payment or a missed loan instalment of a particular month could be construed as events that could harm your credit worthiness in this context.
As the home loans make a transition from the MCLR-based system to such external benchmarks, the rate of interest may see some changes.
Harsh Roongta, a Mumbai based registered investment advisor, said: “These guidelines are applicable to commercial banks. We have to see how housing finance companies react to this. Will there be more regulations for them? Will RBI make the frequency of resets uniform for all lenders as suggested by Janak Raj committee? How existing home loan customers are treated in the process of transition? We will get more clarity once the final guidelines are out.”
The final guidelines will be out by December-end this year.
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