Most individuals paying EMIs in case of a home loan, car loan or for that matter any loan, look up to the Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC) announcement on the policy rates. A repo rate cut or an increase is typically seen as a signal in the movement of the interest rates in the economy.
However, it has often been witnessed in the past that when the repo rate is cut, banks take time to pass on the full benefit quickly to the borrowers, but when the repo rate is increased, it gets passed on to the borrower immediately. Repo rate is the rate of interest at which banks borrow money from the RBI. As and when the RBI cuts the repo rate, there is money available with banks at a lesser cost and this, in turn, helps keep the lending rates low.
Since April 2016, the home loan rate is linked to bank’s Marginal Cost of Funds Based Lending Rate (MCLR), which is an internal benchmark and is a reflection of the bank’s own cost of funds.
However, the time lag still existed and in December 2018, the RBI had recommended the use of external benchmarks by banks for their floating rate loans instead of the present system of internal benchmarks such as Prime Lending Rate (PLR), Benchmark Prime Lending Rate (BPLR), Base rate and MCLR.
The RBI had proposed that all new floating rate personal or retail loans (housing, auto, etc.) extended by banks from April 1, 2019, shall be benchmarked to one of the following:
- Reserve 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.
Taking a cue, the country s largest lender, State Bank of India announced that from May 1, 2019, it is going to link interest rates on savings deposits above Rs 1 lakh and short-term loans to Reserve Bank of India s repo rate. The move was seen as an attempt to align lending rates to policy rates.
Going forward, the MCLR regime will continue but by linking the savings deposits rates to the repo rate, the cost of funds will largely move in tandem with policy rates, thus ensuring better transmission.
The banks get the flexibility to manage their Asset-Liability Management (ALM) better than before. However, even in this SBI new mode, the lending is still linked to an internal benchmark.
In its statement on Developmental and Regulatory Policies issued on April 4, 2019, the RBI states that it has been decided to hold further consultations with stakeholders and work out an effective mechanism for transmission of rates. This effectively means the approach to link lending rates to an external benchmark has been put in abeyance as of now.