From April 1, floating interest rates to be decided by markets: How your home, auto loan rates will be affected

Currently, banks follow system of internal benchmarks, including Prime Lending Rate (PLR), Benchmark Prime Lending Rate (BPLR), Base rate and Marginal Cost of Funds based Lending Rate (MCLR). MCLR is the floor rate below which banks are not allowed to lend. So based on the cost of funds, banks have a number of MCLRs for one month, one year, and so on. The RBI has decided to remove MCLR rates from April, 2019 and has asked banks to link floating interest rates on personal, home, auto and MSEs to external benchmarks like repo rate or treasury yields.

The RBI had shown its disappointment on various occasions at the way banks had been deciding MCLR rate. RBI had stated several times that banks were not passing the benefits of reductions in RBI policy repo rate to borrowers. 

The proposal to shift to external benchmarking of floating interest rate was suggested by an internal study group set up by the RBI to review the working of the MCLR system. 

In its 'Statement on Developmental and Regulatory Policies', the RBI on Wednesday said, "The Report of the Internal Study Group to Review the Working of the Marginal Cost of Funds based Lending Rate (MCLR) System (Chairman: Dr. Janak Raj) released on October 4, 2017 for public feedback, had recommended the use of external benchmarks by banks for their floating rate loans instead of the present system of internal benchmarks [Prime Lending Rate (PLR), Benchmark Prime Lending Rate (BPLR), Base rate and Marginal Cost of Funds based Lending Rate (MCLR)]."

"...it is proposed that all new floating rate (for) personal or retail loans (housing, auto, etc) and floating rate loans to Micro and Small Enterprises extended by banks from April 1, 2019 shall be benchmarked" to repo rate, or 91/182 Treasury Bill yield or any other benchmark market interest rate produced by the Financial Benchmarks India Pvt Ltd (FBIL). The spread over the benchmark rate - to be decided wholly at banks' discretion at the inception of the loan - should remain 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," the RBI said.

The RBI will issue the final guidelines linking the interest rate to external benchmarks by the end of this month. Retail customers will get more transparent and a fair pricing for loans as new system will come into effect on April 1, 2019. 

It will become difficult for banks to lure customers with lower rates and then raise rates surreptitiously. Under the new regime, banks will have the liberty to fix loan rates based on the present pricing system, but once fixed, it will be linked to an external benchmark announced by RBI. For instance, if it is pegged to the repo rate, whenever that rate changes, it will reflect in interest rates. Banks will not be able to change your interest rates unless the external rates change.

Banks will now have to follow one of the following external benchmarks to set the floating interest rate:

RBI Bank of India policy repo rate or Government of India 91 days Treasury Bill yield produced by the Financial Benchmarks India Private Ltd (FBIL) or Government of India 182 days Treasury Bill yield produced by the FBIL or Any other benchmark market interest rate produced by the FBIL

Currently, the policy repo rate stands at 6.50%. Whereas the overnight treasury yield presented by Financial Benchmarks India Private Ltd (FBIL) shows 6.47% from previous 6.50%.

According to a Zee Business report, the spread over the benchmark rate — to be decided wholly at banks’ discretion at the inception of the loan — should remain 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 means that even if a bank has decided to hike a lending rate in near-term future, the old borrowers interest rate will not be impacted and continue to be remain as it is.