RBI’s new rules on floating rate loans from 1 April: Calculating cost won’t be mathematical nightmare for borrower anymore

Like a father who tries hard to instill good habits in his disobedient child, over the years the Reserve Bank of India (RBI) has been requesting, nudging and even scolding banks for keeping the borrower in dark, giving a total miss to the idea of transparency in lending. Even bankers themselves often didn’t quite understand how the rate is arrived at. The RBI kept experimenting with methodologies to calculate loan rates from Prime Lending Rate (PLR) to Benchmark Prime Lending Rate (PLR) to base rate to Marginal Cost Lending Rate (MCLR). All of these had some or other flaws. For instance, BPLR is the rate at which banks’ prime borrowers get money but then deciding who fits to be a prime borrower often led to disputes.

The problem with the RBI always was that it couldn’t have directed banks outright on rates beyond tweaking the methodology and occasional nudging, because that would have worked against the idea of a free interest rate regime.

In deregulated interest rate regime, the decision on all types of rates is up to the banks, not the regulator. But margin-hungry banks have always found a way around to beat the central bank formulae and keep the customer in dark about what’s really going on with his lending rates over time and when respective benchmark rates are tinkered with.

The RBI, on Wednesday, laid out the rules for yet another switch—from MCLR (internal benchmark) to external benchmarks-based (repo rate, treasury bill yield) lending system. Banks will have to implement this for all floating rate loans from 1 April , 2019. These include auto, housing loans and loans to small companies.

Will this new method work well for both the bank and the customer? One needs to wait for the detailed guidelines to see how exactly the methodology will work but prima facie this model, of course, gives hopes of a major step on the way to real transparency.

There is not going to be much change at the final lending rate since banks have been clearly given the freedom to decide the spread above these benchmarks.

Banks can decide this factoring in multiple parameters such as the borrower rating, tenor premium, administrative charges and category of loan. For example, banks can impose a spread of 250-300 basis points above the repo rate of 6.50 percent or 91-days T-Bill yield of 6.81 percent. But compared with the MCLR calculation, this is model looks much simpler and the consumer can always ask the bank about the rate rationale citing the easily available external benchmark rate.

Another good thing is that RBI has clearly stipulated that the spread should remain same “unchanged through the life of the loan, unless the borrower’s credit assessment undergoes a substantial change and as agreed upon in the loan contract”.  This would mean that customers will likely have a fair amount of certainty about the rate throughout the tenure. Basically, this will mean more transparency in the process as far as the consumer is concerned.

On the other hand, the change is unlikely to have an impact on banks’ margins although they will have to now prepare for a change in the processes and adjust their asset liability balance. As the RBI said, the lenders are free to offer different external benchmark linked loans to different categories but must have a uniform external benchmark within a loan category. This means once a bank accepts a certain benchmark, say 91-days T-Bill yield, it cannot change that for that particular loan category, say retail housing loans, but is free to use another benchmark for a separate category, say MSME loans.

“At least a borrower will now easily understand which benchmark is used to calculate his loan rate whereas in MCLR this was slightly difficult,” said Siddharth Purohit, research analyst at SMC Global Securities.

To sum up, the retail borrower can now question the bank as to why their floating loan rates are going up or down looking at the change in the respective benchmark rate. This was not the case with MCLR where even banks were not sure how exactly the marginal cost is computed. Calculating cost won’t be a mathematical nightmare for the borrower anymore.