Why are the banks asked to shift from MCLR to an external benchmark? Read on to find out.
Repo Linked Lending Rate: If you are looking for a home loan, car loan or a personal loan from a bank, new borrowing rules are in place for you. The lending mechanism of banks is going to change from today, i.e. October 1, 2019. As a borrower, your home loan (or any other retail loan) interest rate will be linked to an external benchmark as decided by the bank. Since April1 2016, banks have been lending at an interest rate linked to their Marginal Cost of Funds based Lending Rate (MCLR).
So, why are the banks asked to shift from MCLR to an external benchmark? The MCLR of a bank is an internal benchmark and largely depends on the bank’s own cost of funds. The downside of MCLR mode of lending was that it failed to transmit the full effect of repo rate revisions. As and when the policy rates came down, the transmission was not complete and even the full impact of lower rates happened with a time lag. Going forward, the lending will be linked to an external benchmark. However, if you are an existing borrower with a home loan or a car loan linked to the bank’s MCLR or the bank’s Base Rate or the BPLR, such loans can be continued till maturity.
Effective October 1, 2019, RBI has made it mandatory for banks to link all new floating rate personal loans to an external benchmark. RBI allows banks to choose any of the four benchmarks and even allows banks to choose a Spread over the benchmark rate.
The four benchmarks that the bank can opt for are:
- Reserve Bank of India policy repo rate.
- Government of India 3-Months Treasury Bill yield.
- Government of India 6-Months Treasury Bill yield.
- Any other benchmark market interest rate published by the Financial Benchmarks India Private Ltd (FBIL).
Most banks have opted for RBI’s repo rate to be their external benchmark. In such a case, it will be called RLLR. The RLLR full form is repo linked lending rate. SBI was the first bank to offer RLLR home loans in July 2019, however, it stopped its scheme in September to relaunch a new version for its borrowers. Subsequently, several other banks such as Canara Bank, Andhra Bank, Punjab National Bank, Central Bank of India, Corporation Bank, IDBI Bank, Bank of Baroda, have already launched their RLLR home loan scheme.
Must Watch: What is Repo Linked Lending Rate, Home Loan? RLLR meaning, comparison vs MCLR
The loans linked to an external benchmark is expected to achieve better transmission of policy rates as and when RBI declares it in its bi-monthly monetary policy meeting. For better transmission, the banks have been asked by the RBI to reset its benchmark interest rate at least once in three months.
Example: If the bank’s RLLR is 6.25 per cent and the Spread is 0.5 per cent, the home loan interest rate effectively becomes 6.75 per cent for the borrower. Now, if the repo rate falls by 25 basis points i.e. 0.25 per cent, the home loan interest rate will see a fall within 3 months by an equal margin. The flip side of RLLR linked loans is that in case the repo rate moves up, the interest rate too will rise without much time lag.
So, the next time, when the RBI revises the repo rate, be ready to see a faster transmission of the revisions on either side – your home loan instalments may rise or fall much quicker.