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New Lending Rate – Five Loopholes RBI Should Have Fixed

New Lending Rate
New Lending Rate

The new lending rate regime based on Marginal Cost of Funds will be implemented from April 01, 2016. There is a lot of anxiety among both potential and existing borrowers. It is because of uncertainty about the new lending rate. The key concern of a borrower is that we should not miss the bus. The new borrowers are postponing the home loan in anticipation of much lower interest rates. On the other hand existing borrowers are worried that banks may charge hefty conversion fees to shift them from Base Rate to new lending rate i.e. MCLR.

This kind of anxiety was last seen when base rate replaced BPLR in 2010. Though i am not a market expert, in my opinion, most of the concerns related to Base Rate are not addressed under the new lending rate regime. There is a possibility that even after implementation of the new lending rate the principal concerns of existing borrowers will remain unanswered.

In my last post on the same subject, Marginal Cost of Funds based Lending Rate – MCLR we discussed whether the new lending rate is beneficial or not. The conclusion was that new lending rate will be financially beneficial only during declining interest rates. My biggest worry is if interest rates don’t fall further than new lending rate might prove to be a disaster for borrowers. The inflation is rising, and experts are predicting that further decrease in interest rates is highly unlikely. Moreover, the crude oil prices will not forever remain at current levels. Experts anticipate a sharp rebound. All these are speculations and anyone’s guess.

The objective of this post is to highlight five loopholes that RBI should have fixed under new lending rate. Even under new lending rate regime, the existing borrowers will be at a disadvantage. The banks may find new ways to keep interest rate differential between existing and new borrowers.

New Lending Rate – Five Loopholes RBI Should Have Fixed

1. Spread or Markup on MCLR: I explained the concept of spread/markup in my post, Impact of Base Rate Cut on Home Loans. The spread is a most potent tool for banks to control the final interest rate. As we observed that after RBI’s 50 basis point repo rate cut, one of the biggest home loan provider increased spread on home loan from 5 basis point to 25 basis point. It was accompanied by 40 basis point cut in Base Rate. Effectively even after base rate cut of 40 basis point, the new borrowers were benefitted only 20 basis point. No scientific reasoning was provided for same by the bank. Being a PSU bank, it was not expected. The same problem will persist under new lending rate. RBI has provided a free hand to banks to add a component of spread to the MCLR. The only consolation in the new policy is that spread will be decided based on bank’s board approved policy.

2. Interest Reset Dates: This point is quite interesting. Banks are free to specify interest reset date on floating interest rate home loan. Currently, the interest reset date is every three months. For almost all floating interest home loans it is 1st Jan, 1st April, 1st July and 1st Oct of every year. Now under new lending rate, banks are free to set periodicity of Interest Reset Date. It can be one year or lower. The interest rate applicable on the date of sanction will be applicable till next interest reset date irrespective of any changes in MCLR between sanction date and reset date.

Now you must be wondering what is wrong in this approach. Let me explain in detail. When the banks anticipate that interest rate will fall in future, the reset date will be max allowed period i.e. one year. On the other hand, when banks anticipate an increase in interest rates, the reset date will be shorter i.e. one month/two months, etc. Through this approach benefit of lower interest rate will not be passed immediately. Whereas burden of higher interest rate will be passed proactively to the borrower.

3. The interest rate differential between New and Existing Borrowers: The grudge of existing home loan borrowers against base rate regime is that it did not address the issue of interest rate gap. The same problem will persist under new lending rate. The new regime will only make transmission of repo rate change faster, but it will not fix the shortcomings of existing Base Rate regime.

4. Transmission of Repo Rate changes to Bond Yield: It is another major concern that is not addressed. In last one year, the bond yields are more or less at the same level despite 125 basis point cut in REPO Rate. Current REPO Rate is 6.75% whereas Bond Yield is 7.749%. In short there is a gap of whooping 100 basis point. You must be wondering why i am explaining all this. The reason being, the cost of borrowing of HFC’s is usually linked to Bond Yield. If banks decide to go aggressive on new lending rate, then there is a danger of small HFC’s being out of business.

At first place, HFC’s don’t have access to cheap CASA funds and on top of it, the borrowing cost of HFC’s will be good 100 basis point more than banks. Banks can borrow at REPO Rate from RBI, but HFC’s will borrow near bond yields. For the success of new lending rates, it is must to fix the gap between Repo Rate and Bond yields. A competition is always good for the growth of mortgage industry. If this anomaly is not fixed, then it will create a virtual monopoly of handful big boys.

5. Not all class of borrowers are covered under MCLR: The concept of floating interest loan is alien to personal loan or auto loan borrowers. The reasoning given by the banks is that these are short-term loans and will remain fixed. I feel sorry for borrowers of the personal or auto loan. The loan of these borrowers is mostly fixed interest. I was expecting that under Marginal Cost of Funds based Lending Rate will cover all types of the loan including personal and auto loans. It was much needed to pass the benefit of lower interest rate to all class of borrowers. RBI policy does not mention that MCLR is only for Home Loans, but currently, floating interest rate is provided only to Home Loan borrowers.

On behalf of all the readers of this blog, i request RBI to fix the loopholes under new lending rate. All the borrowers both new and existing & also personal/auto loan borrowers should be treated equally. I do agree that it is not possible to immediately pass the benefit of lower interest rate to existing borrowers. At the same time, over a period a bank can take steps to bridge the gap between interest rate offered to new and existing borrowers without conversion fees. The conversion fees of 0.25%-0.5% of the outstanding loan are an enormous financial burden. A borrower may opt for multiple conversions during Home Loan tenure. On the other hand, some banks allow conversion only once during home loan tenure. A bank generates a good income from conversion fees. Bank can always refinance existing loans and pass benefits to existing borrowers.

 Copyright © Nitin Bhatia. All Rights Reserved.

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sandeep bansal
sandeep bansal
8 years ago

Please tell if you aware how MCLR will fix in HDFC old loans, will they provide same spread/discount as on exist BPLR, what is there interest rate reset period. kindly tell if you aware..

Nitin Bhatia
Nitin Bhatia
8 years ago
Reply to  sandeep bansal

As i shared in my posts that MCLR will be declared only by banks not by HFC’s like HDFC. In order to remain competitive, HDFC will increase their spread/discount for new borrowers. I doubt that benefit (if any) will be passed to existing borrowers.

Tom
Tom
8 years ago

Dear Mr Nitin, I am an existing SBI home loan customer in the floating rate base rate regime. We have received benefits of interest rate reductions caused due to last two rate cuts in the year 2015, with out any action from our side and with out any conversion fees.You mean that this situation will change and we will be forcibly moved over to the MCLR regime this year and then we have to pay conversion fees every time !

Nitin Bhatia
Nitin Bhatia
8 years ago
Reply to  Tom

You will not be forced to move to MCLR. You have choice to either maintain status quo i.e. home loan is linked to base rate or shift your home loan from base rate to MCLR.

Tom
Tom
8 years ago
Reply to  Nitin Bhatia

Dear sir,finally SBI has come out with the 1 year re-set MCLR rate of 9.2 % plus spread.SBI spokesman also stated that that for a borrower who chooses a 1 year re-set, lending rates will come down by about 10 basis points.But wont this be accompanied by a conversion fee too ? My current interest rate is 9.4 % after the latest base rate revision and the OS loan is about 75 Lacs. Is this saving of 0.10 % interest after paying a conversion fee, good incentive for switching over to MCLR regime in my case ? If yes, wont we miss out benefits from any downward base revisions in the next 1 year ? How to actually analyse the pro/cons ? Surely 100s like me are waiting for your advise !

Nitin Bhatia
Nitin Bhatia
8 years ago
Reply to  Tom

Any change in MCLR will be directly passed to the borrowers and there will not be any conversion fees for the same. You can switch to MCLR from Base Rate without any conversion fees but your rate of interest will remain same. As i understand your markup under MCLR will increase by 0.10%. In my opinion, you should continue with base rate for some more time to observe/understand volatility in MCLR.

SV Prasad
SV Prasad
7 years ago
Reply to  Nitin Bhatia

Sir, I am a homeloan customer with IDBI bank and as offered by IDBI bank also earlier this month, conversion from my existing floating rate of Base Rate+0% (9.75%) to MCLR based interest rate would be free of charges but there would not be any change in current interest rate figure. Though the terms communicated are not very clear, This change as I could understand is effected by adding a spread of (current base Rate Minus current MCLR for 1 year) which would be 9.75%-9.30% = 0.45%., to satisfy their condition of no change in current interest rate. And the worst part is that this spread will continue for the entire balance loan tenure of 10 years form me. Alternatively there is another option with some ad-hoc (but variable anytime in future) conversion fee of 0.10%, to benefit me to the current home loan offer terms for new customers which is MCLR+0.15% spread = 9.45% with a reset of 1 year. Earlier I thought of waiting till August RBI policy rate announcement on 09.08.16 but based on Sh. Rajans statements and recent inflation rise, looks like there will not be any reduction in repo in August policy. Possibly the new RBI governor more aligned with the FM & Govt. eagerness to reduce rates, may effect a reduction in October policy rate and I can expect a significant reduction say min. 0.25% in MCLR rates of my bank IDBI., atleast for next one year if I opt for fee based conversion then. My worry is the bank may scale up conversion fee if they find the benefit is significant., as Base Rate though not used for new loans , would still be under their control and could be kept a bit higher artificially to encourage old customers move to MCLR based rates. Any idea how other banks are pricing this conversion fee, like SBI, ICICI, HDFC etc. ( I paid 0.5% for one time conversion from BPLR to Base rate when my loan was with SBI earlier, which was very expensive.and still my rate was not fixed at BR but BR+ some spread, I felt cheated and moved out my loan with a top up to IDBI at BR and I heard it was later reduced later to 0.25 or 0.1%

What would be your view on this, please offer it liberally as I would not consider amounting it to advice

Nitin Bhatia
Nitin Bhatia
7 years ago
Reply to  SV Prasad

Firstly i would like to congratulate you for being an informed borrower. Really appreciate your thorough understanding of the subject. Ref to your queries

There is no standard policy on conversion rate. A bank may change it in future. In my opinion, you can shift the loan from base rate to MCLR. Pay the conversion fees and reduce your home loan interest rate. With base rate you have hit the wall till bank decide to reduce base rate. Your assessment on RBI’s stance is same as mine. I am also expecting new RBI governor to be more aligned with Govt thus probability of repo rate cut is high. At the same time, the benefit of any future repo rate will be transmitted faster through MCLR compared to base rate. Therefore, it is another reason for suggestion to shift to MCLR.

Also remember that high NPA’s are big deterrent to lower interest rate. Till date there is 1.5% cut in repo rate but the benefit of only 1% is passed to the borrowers and that too not by all the banks.

Though there is a scope of further rate cut but not much from current levels. Based on past experience expect transmission of only 2/3rd benefit. You can wait till Oct for more clarity.

nishant2136
nishant2136
7 years ago

This is the response I received from CanFin Homes.
Dear Sir,

Please refer our Fair Practice Code, available in our website as well as in the branch on the said matter. Attached please find the relevant extract of the said code for your ready reference. We have recently reduced the interest adjustment charges to 0.25% of the outstanding amount or Rs.5000/- whichever is lower.

We may also add that our risk profiling method is transparent and is done in front of the customer and the customer is advised about the rate of interest based on the risk profiling, only then the sanction is done and after the acceptance of the same by the customer, loan is disbursed.

It will not be out of place to mention that the risk profiling is a prerogative of the Company based on their perception of risks included in a particular loan. There is no guidelines regarding the same by NHB, our Regulator. Also, NHB has withdrawn their guidelines on uniform rate of interest, subsequent to which we have dispensed with the same.

We request you to contact the branch to make the reduction of roi (depends upon your credit risk rating) effective in your account.

Thanks & regards,

Nitin Bhatia
Nitin Bhatia
7 years ago
Reply to  nishant2136

This is standard response. You may check the revised interest rate offer and then decide.

Suman
Suman
7 years ago

Dear Sir,

Wish you Happy New Year, 2017.
I have a home loan (Max gain) from SBI and the loan started on 16th Nov, 2014. At starting the interest was 10.15% and at present the interest rate is 9.4%. Now, SBI has reduced the interest to 8.1% form as in news.
Is this interest rate applicable for my loan? I have checked online and still the interest is 9.4%. Should I have to contact the bank to reduce the interest rate?

From news paper I came to know that, the interest reset period for SBI is annual. Then should I have to weight up to Nov, 2017?

Please help.

Nitin Bhatia
Nitin Bhatia
7 years ago
Reply to  Suman

1. SBI has reduced MCLR to 8.1% not home loan interest rate. The home loan interest rate is 8.65% only for new customers.
2. It seems your home loan is linked to base rate. You may check your home loan reset date and keep an eye on change in base rate. Also check with the bank if it is feasible to reduce spread by paying conversion fees.
3. The annual reset period is for MCLR linked home loan. If your home loan is linked to base rate then in all probability the reset period is quarterly. Please check your home loan agreement for more details.

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