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RBI to link loan interest rates to external benchmarks replacing MCLR

Home Buyers as Financial Creditors

Borrowers can rejoice as the Reserve Bank of India (RBI), in its latest monetary policy, has proposed that interest rates on all loans, including home loans, auto loans and loans given to micro and small enterprises, will be linked to external benchmarks instead of the presently used marginal cost of funds-based lending rate (MCLR), effective from April 1, 2019. Since April 2016, interest rates on all loans have been linked to MCLR. Before that, they were linked to banks' base rates.

Under the new guidelines, the loans will be benchmarked to either RBI’s repo rate or the yield on the government’s treasury bill of 91 days, or the yield on the government's 182-day treasury bill, or any other benchmark market interest rate produced by Financial Benchmarks India. As a result, any change in rates of external benchmark rates will be immediately passed on the borrower. Earlier, banks used their own judgement in revising their benchmark MCLR rates in response to policy rates and were blamed for not passing the benefit of a rate cut to their borrowers. A common grievance of borrowers has been that whenever RBI raises the policy rates, the banks were quick to pass on to the loan takers, but the same was not true in the case of downward revision of rates. However, now the transmission of policy rates is expected to become more transparent with RBI replacing MCLR with the external benchmark, which is an independent benchmark and banks cannot control or influence the change in these benchmark rates.

The spread over the benchmark will continue to be decided by the bank at its discretion. It should remain unchanged throughout the life of the loan unless the borrower’s credit assessment undergoes a substantial change and as agreed upon in the loan contract. The banks will be free to offer these external benchmark linked loans to other types of borrowers as well. The RBI said that in order to ensure transparency and standardisation, and to make sure that borrowers easily understand loan products, banks will have to adopt a universal benchmark for any particular category of loan. This would mean that the same bank cannot adopt multiple benchmarks within a loan category.

The final guidelines in this regard will be issued by the central bank by the end of December 2018. However, the new guidelines are expected to usher an era of transparency to borrowers.

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