Reserve Bank of India has ushered in a breather for home loan borrowers who can now enjoy fair play in its pricing which is going to be decided by market dynamics in the place of judgement by banks. The fifth bi-month policy meet of RBI proposed a floating rate of interest on home loans which is going to be collated against an external benchmark 1st April 2019 onwards. This move of the central banker is expected to tag along greater transparency in the home loan market.
On 5th December 2018, RBI took the decision to make it mandatory for all banks to link every single floating rate loans which have been extended to small business and individuals along with an external benchmark. The yield on RBI’s repo rate on the 91 or 181-day treasury bill or any similar yardstick which is produced by Financial Benchmarks of India (FBIL) can be taken as the center of measure.
This has brought along huge respite for home loan borrowers who had been perennially complaining about the role of bank in raising the rate of interest in sync with the economy but were comparatively slow in passing on benefits during growth scenarios. Various methods were used over the years for fixing the loan rates and their movement over time in association with our economy’s rising and falling rates like marginal cost of lending rate (MCLR), bank prime lending rate (BPLR) and prime lending rate. These benchmarks were internal to the bank’s functioning and failed to pass on the associated benefits to end users in a pro-active fashion.
MCLR-based products were introduced by the regulator in April 2016 to overcome this situation. Home loan products linked to MCLR comprise of three core elements of the spread, frequency of revision and MCLR which the end users are expected to understand pretty well. Mr. Sukanya Kumar, the founder of home loan advisory firm RetailLending.com recently revealed that, “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.”
Janak Raj, the principal adviser of RBI’s monetary policy department headed an internal study group which was set up by the central banker wherein he observed that a sizeable chunk of the bank’s loan portfolio has continued to remain at base rate with some even at BPLR thus hampering monetary transmission. It was thus understood that the banks could not transfer the benefits of rate cuts to borrowers of home loan. The group had thus recommended periodical resetting of floating loan interest both for retail and corporate clients from annually to quarterly basis for boosting up the pass-through to actual lending rates from monetary policy signals.
These recommendations have been accepted by RBI both for small and medium firms as well as retain clients. The RBI policy statement released on 5th of December 2018 tried to put an end to the confusion arising out of multiple benchmarks by clearly stating that henceforth multiple indexes cannot be offered by banks for their loan products. Thus, existing products which are based on BPLR, PLR and MCLR are soon going to become history which in turn will lead to standardization of home loan products. It is also expected to become easier for the customers to understand the products and pick the one which suits them best.
Citibank is the solitary lender in India which is making use of an external benchmark for all home loans. A similar scheme was introduced by the banker in March 2018 wherein the rate of interested was synced with the 91-day treasury bill of Indian government where the treasury bill benchmark linked lending rate (TBLR) is reset on a quarterly basis. Rohit Ranjan, the head of secured lending at Citibank India revealed that, “We believe the use of external benchmarks for floating-rate home loans provides transparency to the end consumer. We have seen a favourable response since its launch in March 2018, with 95% of all new bookings opting for our three-month T-bill rate-linked home loan product.”
It is thus clearly understandable that the banks cannot exercise control over the rates in this new regime where benchmark is linked with an external factor. Customers can thus easily compare the offers of various lenders before deciding on the bank they wish to proceed with. RBI deputy governor NS Vishwanathan said that, “We have been moving towards enhancing transparency on loans. As part of this, we moved from base rate to marginal cost of lending rate. In furtherance of this objective, we are making it mandatory for banks to link personal and SME loans after April 2019.”
In spite of serving as an effective means of interest rate transmission, the new system of external benchmarks will mean that the home loans shall be priced by considering the market forces. The spread shall be determined at the time of loan disbursement according to the new recommendations. It will thus spread out evenly over the benchmark throughout the tenure unless any alteration happens to the borrower’s credit worthiness. Thus, a simple missed loan installment or a missed credit card payment in a particular month can jeopardize your credit worthiness in this context.
Mumbai based registered investment advisor Harsh Roongta holds the view that, “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 the end of December. This RBI policy’s ultimate effectiveness in adding inertia to demand or curbing the same will be effective only if adequate rate actions are passed on by the banking bodies. Previously it was seen that banks denied to bring down rates in spite of RBI’s directive just for protecting their margins. They even refused to pass on rate hikes during growth phases which further leads to rise in interest rates. However, in the presence of an external benchmark, the banks won’t be left with any other choice apart from following the same.