Home loans set for floating interest rate revamp from April 2019

RBI said that it will be mandatory for banks to link all floating rate loans to an external benchmark from April 2019. Here's everything you need to know

Home loans set for floating interest rate revamp from April 2019

The Reserve Bank of India (RBI) has confirmed that it will be mandatory for banks to link all floating rate loans to an external benchmark from April next year. These loans, which are extended to individuals and small businesses, will be linked to the RBI repo rate, 91-day Treasury bill yield, 182-day Treasury bill yield, or such other benchmark as deemed by the Financial Benchmarks India Pvt Ltd. 

This was declared by the RBI in its fifth bimonthly policy meet. Presently, Citibank is the only lender that uses external benchmarking for its home loans.

Among several observations, the RBI noted that banks were lethargic in their response to pass on rate cut benefits to borrowers. This decision is based on the recommendations of the RBI’s monetary policy department headed by its principal advisor Janak Raj. The move is expected to bring more transparency to the process and ensure more efficiency in the transmission of the rates to the end user. 

The RBI has been trying to address the issue around floating rate loans, which were hesitant to come down even in the face of declining interest rates. To tackle this, it asked banks to replace the prime lending rate (PLR) with the base rate system and then the marginal cost of lending rate (MCLR). However, the RBI apparently wasn’t happy with either.

Related: 5 reasons to go for home loan refinance 


What’s going to change

Banks currently rely on MCLR. The interest rate is determined by taking this MCLR and adding a spread on it. Being a one-year MCLR, the interest rate will be valid for a year, after which the rate will be reset based on the new MCLR. Its predecessor (the base rate system) ensured that banks didn’t offer loans below a certain percentage, but the changes in interest rates were not effectively passed on to customers. 

The practice of adhering to an external benchmark will be far more transparent than the previous systems. Citibank confirmed that in 95% of its home loans disbursed since March 2018, customers opted for the 91-day Treasury bill-linked option. Notably, Citibank launched its externally benchmarked home loan product in March 2018, something that will be mandatory for all lenders from April 2019.


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How borrowers stand to benefit

Borrowers have often complained that banks were quick to raise the home loan interest rate whenever there was a hike, but far too slow in passing on the benefits of a cut in the interest rate. Consumer discussion forums are filled with cases where the bank didn’t bother to inform customers that the interest rate has fallen and they should apply for the reduced rate. However, in the new system, banks will not be able to control the rates and customers will be able to compare various loan offers in a more uniform manner.

The RBI’s observations

The internal study group noticed that the entire home loan market lacked transparency and proper understanding was not available to the customers. The shift from bank PLR to MCLR didn’t translate to ground reality and a large number of loans continued at a base rate or BPLR. The RBI categorically observed that banks were not passing on the benefits of the home loan rate cuts to borrowers.


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What the future holds

For now, the RBI has recommended that the resetting of interest rates by banks on floating rate loans be done every quarter instead of yearly. It also said that banks will not be able to use multiple benchmarks for their loan products in a particular category. Consequently, current interest calculation mechanisms such as PLR, BPLR, and MCLR will be done away with and home loan products will be much more standardised. 

Related: Smart ways to reduce your loan stress 


In addition, the RBI also recommended that the spread used for determining the interest rate will be fixed at the time of disbursement of the loan. This will be reconsidered only if such reconsideration is agreed to in the loan contract and there is a substantial change in the borrower’s credit assessment. 

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