Marginal Cost of Funds Lending Rate

• When the Reserve Bank of India (RBI) made it mandatory for banks to link their new retail loans to an external benchmark from 1 October 2019, it seemed an obvious choice for existing home loan borrowers to shift from the marginal cost of funds-based lending rate (MCLR) regime to the external benchmark-linked one.
• Unlike earlier, the new regime aims to make the transmission of policy rate cuts faster and more transparent. Between February and October 2019, the policy rates were cut by 135 basis points (bps), but the interest rates fell only by up to 44 bps between February and December 2019. One bps is one-hundredth of a percentage point. The benchmark-linked regime is expected to resolve this problem. Most banks opted for RBI’s repo rate as their benchmark.
• But after the 6 February monetary policy announcements by RBI, the choice between the old MCLR and the new benchmark-linked regimes may not seem that obvious.
• In its latest policy, RBI did not cut the repo rate and loans linked to it remain unchanged. However, the regulator took some steps to bring down banks’ cost of funds, which is expected to reduce MCLR, benefitting borrowers who are still with the old regime.
• If you are sitting on the fence with a loan linked to MCLR and contemplating a jump to a benchmark-linked one, know that the shift may make sense only if the differential is significant. Here are the details.

What’s new?

• RBI introduced an instrument called long-term repo operations (LTROs), which will inject liquidity into the system and is expected to bring down the cost of funds for banks.
• Through LTROs, banks can borrow from RBI at the repo rate (5.15%) for one- and three-year tenures. This means, since banks get cheaper credit, they are expected to lend at lower rates.
• Consequently, banks may revise MCLR downward. This could benefit many borrowers who have their home loans linked to MCLR.
• According to bankers, more than 80% of floating rate loans are still linked to MCLR.
• Some banks have, in fact, already reduced their MCLRs.
• Bank of Baroda reduced its one-year MCLR by 10 bps to 8.15%, effective 12 February 2020.
• State Bank of India (SBI) lowered MCLR by 5 bps across tenures to 7.85%.
• Some other banks are awaiting clarity before they reduce MCLR, said experts.

Should you switch?

• In March 2019, a leading public sector bank was offering an interest rate of 8.95% for salaried men looking for a home loan between ₹30 lakh and ₹70 lakh, according to data from Myloancare.in, an online marketplace for loans.
• If someone had taken a loan in March 2019, the borrower would see his interest rate fall to 8.3% (based on the current spread that the bank is charging above MCLR) when the rates reset in March 2020, the reset date, from when a new rate is applicable- the majority of MCLR-linked loans are reset annually.
• If the same borrower shifts the loan to the repo-linked regime, the interest rate on his loan would be 8.2% (the best rate offered by the bank in question for a similar profile) on the reset date in March 2020.
• After the reset, the difference between the rates under the new and old regimes will be a mere 10 bps. Here, the borrower does not benefit much by shifting to the repo-linked rate.
• Also, all the customers may not get the repo-linked rate of 8.2%. If the difference between repo- and MCLR-linked rates widens, the customer can shift to the new regime.
• The same is the case with a leading private bank, which is currently offering repo-linked interest rates of 8.40-9.05% for a home loan between ₹35 lakh and ₹75 lakh for salaried men.
• Borrowers in the same segment, who took the loan in March 2019, would see an interest rate of 8.6% from the current 9.2% when it comes for the reset in March 2020.

In the above two examples, the difference between interest rates on loans linked to MCLR and repo rate may not be much, but that may not be so in every case since it would depend on when you took the loan and the reset date.

Experts Opinion:

Mr. Ajoy Nath Jha, Chief Risk Officer, IDBI Bank:

If your loan is going to reset in the next two-three months, sticking to MCLR could be beneficial.  There are expectations that higher liquidity would result in lowering of MCLR. But we have to see the extent to which the cost of funds would come down for banks.

Mr. Jaideep Iyer, Head of strategy, RBL Bank:

• If your MCLR-linked loan has already been reset in the past four to six months, and there’s a considerable difference between the existing rates and what the bank is offering to the new customers, you should consider switching. If the difference is marginal, and your loan may reset in the next three to four months, it’s best to wait until the next monetary policy.
• Existing borrowers on MCLR should continue with it for now as there is scope for rates to fall. There will be no change in the repo-linked lending rates unless RBI cuts policy rates. It’s best to wait and watch.

Mr. Aditya Mishra, founder and CEO, Switchme.in:
(It is a platform that helps borrowers shift their home loans to other financial institutions)

• The cost of switching to the new regime may not be much. Bank of Baroda, for example, charges ₹2,500 as a one-time switching charge.
• If you are moving from MCLR to the benchmark-linked rate within the same bank, the lender may not re-evaluate you.
• However, if your lender has started offering differential rates based on credit scores, it will check your credit profile.
• If the credit score has fallen, the lender will charge a slightly higher rate.

Loan transfer:

• According to Mishra, if the borrower is not with the top three public sector banks that offer the best rates in the industry, it’s best to opt for a loan transfer instead of switching from MCLR to repo-linked rates with the same lender.
• In some cases, banks are offering repo-linked loans at rates that are 35-50 bps higher than the cheapest rate available in the market. But transferring a loan from one bank to another can be a complicated affair.

Mr. Gaurav Gupta, Co-Founder and CEO, MyLoanCare.in

• To start with, you will be re-evaluated.
• The interest rates that banks advertise are card rates. Not all borrowers would get the advertised rates.
• For example, SBI’s lowest rate is 7.95%, which is available for loans below ₹24 lakh and only for those buying their first home.
• Then, each bank segments customers differently based on their credit score.
• Also, there are costs such as processing fee and mortgage charges that you may have to bear.

Mr. Harsh Rungta (a Mumbai-based Sebi-registered financial adviser and a former banker)
Keep in mind

If switching to the new regime doesn’t make sense for you now, consider doing it later as repo-linked loans are a more transparent option.  MCLR is not transparent. Borrowers have no way to know how MCLR would change on different policy decisions. External benchmark was introduced to make transmission transparent and quicker. When the policy rates change, the borrower knows that within three months, banks will revise his home loan rates.

In the past, banks were slow to reduce benchmark rates when the central bank cut its policy rates. But they were quick to increase it when RBI hiked rates. The difference between the two regimes is not much for many borrowers because repo rates were introduced just over four months ago, whereas policy rates have come down by 135 bps between February and October 2019. Had the repo rate regime been implemented earlier, there would have been a considerable difference between the rates under the new and old regimes.

Key Terms:

• Downward revision in rates could benefit those who have their home loans linked to MCLR
• Even if MCLR makes sense now, repo-linked rate should be your long-term choice