RBI push to link loans to repo rate will not bring cheers to home-loan borrowers; banks have again found a way not to fall in line

If there was an expectation that the new repo-rate linked loan rate-setting mechanism will lower the EMI burden on borrowers, it has been proved wrong. As expected, banks have begun playing with the premium (or spreads) above the benchmark rate to protect their margin.

To start with, the nation’s largest lender, State Bank of India (SBI) has increased the spread over the new benchmark rate, repo. It has actually increased the spread from what it was charging before over the benchmark rate—by 265 basis points as against 225 bps it used to charge before. With this, the lowest home loan rate will be between 8.20 percent and 8.55 percent as compared with 8.05 percent earlier. Other banks are likely to follow this method and adjust the spreads over the benchmark rates.

Representative image. Reuters

Given that the SBI offers the lowest home loan rate among banks, it is safe to assume that the average home loan rate in the industry is set to move up from what it was before under the new external benchmarking system. In an earlier article, this writer had argued why lending rates are unlikely to come down even with external benchmarking. This has precisely happened now. Banks can further increase the spread over the benchmark rates taking into account the borrower’s risk profile.

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With SBI’s move, now it is even more obvious that the new benchmarking method will not ease the EMI burden of the borrower but the new method has some positives too. It will certainly bring more clarity to the whole rate setting process from a customer’s point of view. Earlier, it would have been difficult for the customer to understand how exactly his/her lending rate is decided over the marginal cost of funds or BPLR or base rate. All these were internal benchmarks and used to differ bank to bank.

(Source: SBI website)

For an average customer, not well informed about bank methodology, it used to be a confusing exercise to make a comparison between different banks before deciding which bank’s rate is more transparent and beneficial for him. Now, assuming repo will be the external benchmark for most banks, one just needs to compare the spread levied by banks to understand the rate structure. Thus, the new external benchmarking assures more transparency.

That said in the infamous tug-of-war between the RBI and banks for effective monetary transmission, banks have won yet another round. Time and again the RBI has expressed its displeasure over lack of proper monetary policy transmission in the banking system. It has been blaming banks for not being transparent enough when setting their lending rates. The regulator has tried to persuade banks to pay attention to the rate cues from the central bank by nudging them constantly. It can’t dictate lending rates to banks because in a deregulated market it’s up to the institutions to decide their rate card.

The idea of pushing banks from the earlier BPLR (benchmark prime lending rate) system to the base rate (minimum lending rate) and later to the marginal cost of funds-based lending rate or MCLR-based calculation was to bring in more transparency in the interest rate-setting process. But, no matter what the RBI tried, banks still managed to find ways to protect their interest margins. They did so by passing on only a fraction of the RBI rate cuts to the customer or adjusting their premiums above the benchmarking rate. Against the RBI rate cut of over 110 bps, banks would have passed on, at best, 30-40 bps to the customer over the last one year. Banks have once again found a way to protect their margins.