Good news for borrowers: RBI to link interest rates to external benchmarks replacing MCLR

Borrowers can rejoice as the Reserve Bank of India (RBI) has proposed that banks will now have to link the interest rates charged by them on different categories of loans to the external benchmarks instead of the presently used internal benchmarks for better transmission of the policy rates.

The home loan takers have often complained about the opacity of interest rate fixing mechanism. Banks have always been blamed for not passing on the rate cut benefits to their customers. A common grievance of borrowers has been that whenever RBI raised the policy rates, the banks were quick to pass on to the loan takers. However, now the transmission of policy rates is expected to become more transparent with the RBI replacing MCLR with external benchmark. As and when the external benchmark rate changes, it will reflect in the change in interest rate of the loan as well.

The RBI in its Statement on Development and Regulatory Policies has proposed that from April 1, 2019, banks to use external benchmarks instead of the present system of internal benchmarks i.e. Prime Lending Rate, Benchmark Prime Lending Rate, Base Rate and Marginal Cost of Funds based Lending Rate (MCLR) to ascertain the lending rates.

RBI said in its statement has proposed that all new floating rate personal or retail loans i.e. housing, loans etc. will be linked to the new benchmark with effect from April 1, 2019.

According to the proposal, the loans can be benchmarked to any one of the following:
a) Reserve Bank of India policy repo rate, or
b) Government of India 91 days Treasury Bill yield produced by the Financial Benchmarks India Private Ltd (FBIL), or
c) Government of India 182 days Treasury Bill yield produced by the FBIL, or
d) Any other benchmark market interest rate produced by the FBIL

However, the spread over the benchmark rate is to be wholly decided by the bank at its discretion. It should remain unchanged through the life of loan unless the borrowers' credit assessment undergoes a substantial changes, said the statement.

The banks are free to offer these external benchmark linked loans to other types of borrowers as well. The bank is required to adopt a uniform external benchmark within a loan category so that there is transparency, standardisation and ease of understanding for the borrowers. This would mean that 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.

The apex bank has proposed these changes after adopting the recommendations made by the study group under the Chairmanship of Dr. Janak Raj to study the various aspects of the MCLR system. The study was done to improve the monetary transmission and exploring the linking of the bank lending rates directly to market determined benchmarks.

According to current RBI mandate, all loans such as car loans, home loans etc. disbursed from April 1, 2016 have to be linked to MCLR based regime. The MCLR based regime has replaced the earlier base rate regime to provide the transparency in the transmission of monetary policy decisions.