Repo-rate linked loans are in the news. Earlier this year, the State Bank of India became the first bank to announce a repo-linked loan. Now, other banks have followed. What does this mean for consumers? Will it lead to cheaper loans? Let’s get a better understanding of this.
WHAT IS REPO RATE?
It is the rate at which the Reserve Bank of India lends to commercial banks. The repo rate is one of the instruments the central bank uses to control inflation and economic growth. The repo rate lays the basis for deposit and loan interest rates in India. One of the RBI’s recent concerns has been the efficient transmission of its rate cuts to consumers. In 2019, the repo rate has been cut from 6.50 per cent to 5.40 per cent. However, this hasn’t resulted in rate cuts for commercial loans required to stimulate economic growth. Therefore, the RBI had in 2018 mandated banks to link loans to an external benchmark that responds better to repo rate movements. The deadline to implement the mandate was April 1; however, banks had asked for more time and are now gradually rolling out repo-linked loans.
HOW REPO-LINKED LOANS ARE DIFFERENT
Since April 2016, all new bank loans were linked to the MCLR (Marginal Cost of Funds-based Lending Rate). The MCLR was a departure from the base rate regime earlier. The RBI’s intention was to allow better transmission of rate cuts to consumers. The MCLR, which is a benchmark set internally by banks, also aimed to provide interest rate switches at fixed intervals. For example, your home loan rate would automatically reset every six months to the MCLR prevalent at the time. While rate cuts happened in a more timely manner, transmission has remained a concern. This year alone, the repo rate has reduced by 1.1 per cent. But consider SBI’s lowest home loan rate which has moved from 8.75 per cent in January to 8.35 per cent today, a decline of 0.40 per cent. Therefore, the RBI is hopeful that a repo-linked loan rate will be more responsive to rate cuts. This, they thought, would only be possible if the loan rate was linked to an external benchmark. The RBI said that banks could pick any of the following as their benchmarks: the repo rate, the 91 or 182 day Treasury Bill yield, or any other benchmark produced by FBIL.
HOW THE LOANS ARE PRICED
After SBI, Bank of Baroda, Bank of India, Syndicate Bank, Union Bank, India Bank and Allahabad Bank have announced their intention to link loans to the repo rate. SBI had earlier announced a Repo Linked Lending Rate which is their benchmark for loans. It is currently 2.25 per cent above the repo rate. As of July, the repo rate was 5.75 per cent therefore SBI’s RLLR was set at eight per cent. This is lower than the SBI’s current one-year MCLR which is 8.25 per cent. On the RLLR, SBI currently applies a credit spread of 40 basis points and upwards. The spread is calibrated based on such parameters as the loan-to-value, loan amount, and the borrower's gender and credit score. Currently, the lowest RLLR-linked home loan rate is 8.40 per cent for loans up to `75 lakh as advertised on the bank’s website. On an MCLR-linked loan of similar size, the lowest rate by the same bank is 8.60 per cent.
HOW DOES THIS HELP THE CONSUMER?
The repo-linked loans will hopefully transmit rate cuts in a more efficient manner. For example, if SBI were to transmit a full, 35 basis points cut to its RLLR home loan customers, this loan would then be priced at 8.05 per cent, which borrowers would welcome wholeheartedly. SBI intends to reset the RLLR at the end of the month of a repo rate cut, therefore the rate revision should happen by September 1. This would energise the other lenders into proactively reducing rates in order to be competitive. So both new as well as existing borrowers would benefit from lower rates across the board.
WHO CAN TAKE A REPO-LINKED LOAN?
As per the 2019 Aspiration Index, buying a home is India’s No. 1 aspiration. Anyone looking to make the most of low interest rates, budget housing schemes, credit rate subsidies under PMAY and the plethora of housing inventory in major cities can take a home loan to fulfil their aspiration. The repo-linked loans are marginally different from MCLR-linked loans. For example, SBI’s RLLR loan can be taken only be new borrowers whose minimum gross annual income is `6 lakh. If you are eligible for such a loan, take advantage of it.