Better transmission, but more volatility for borrowers: Experts

The Reserve Bank of India’s unhappiness with slow transmission of its repo rate cuts could soon lead to a new external benchmark rate – the Treasury bill rate, certificate of deposit rate or the apex bank’s repo rate. The apex bank’s Internal Study Group has proposed that one of these three external benchmarks should be implemented from April 1, 2018, and all lending rates should be linked to it, and even bulk deposit rates.

But some industry experts believe that the move isn’t necessary. Says Keki Mistry, vice-chairman and chief executive officer, HDFC: “I believe that an external benchmark isn’t necessary. Today, customers who have a floating rate loan are free to prepay and move to another bank or housing finance company if they are unhappy with the rates being charged by their bank. And there is no penalty as well.” Mistry believes that the move will make home loan rates more volatile.

Volatility may also rise due to more resets. “The reset clause, which is typically one year, impedes monetary  transmission  as  the  pass-through  of  monetary  policy  changes  to  existing floating  rate  loans  is  delayed.  The Study Group, therefore, recommends that  the periodicity of resetting the interest rates by banks on all floating rate loans, retail as well as corporate, be reduced from once in a year to once in a quarter,” the report says.

The report also proposes that all borrowers should be shifted to the new benchmark without any cost. This is, perhaps, the most important part from the borrowers’ perspective as many are still stuck with earlier benchmarks, such as the benchmark prime lending rate and base rate regimes, which the banking industry no longer uses. Even after 18 months of introducing the marginal cost of funds-based lending rate (MCLR), only 25 per cent of retail and 40 per cent of corporate loans have been shifted to the new benchmark.

According to the Study Group’s report: “A few banks made little effort to migrate small and retail customers from the base rate system to the MCLR regime, as there was no proper dissemination of the switchover option through the branches of the banks or their websites. A number of banks levied a one-time switchover fee on migration of advances from the base rate to the MCLR regime. Moreover, it was observed that the effective interest rate burden on the borrower remains the same even after switching to the MCLR regime from the base rate regime. In a few cases, interest rates were raised by as much as 300 basis points.”  

From a borrower’s perspective, shopping for a loan, currently, can be seriously confusing. Though the benchmark MCLR is the same for all banks, they use different tenures. For example, State Bank of India and Punjab National Bank use the one-year MCLR while others like HSBC and Citibank use the three-month MCLR as benchmarks. And some like ICICI Bank use two benchmarks, the six-month and one-year MCLRs. Then, there are different offers that provide some 10 basis point benefit for women and so on.

The proposal of a single benchmark for all consumers will bring down this confusion significantly. While banks will be free to decide the risk premium or spread, they cannot change it in the future unless a clear credit event that necessitates the change. Madan Sabnavis, chief economist, CARE Ratings, believes that there will be more transparency and transmission will improve after the introduction of the external rate. “However, with the bank allowed to decide the risk premium, things will not change dramatically in terms of rates,” he adds.    

According to Ashvin Parekh, managing partner, Ashvin Parekh Advisory Services: “The new measure is good from the perspective of borrowers. However, profitability of banks, which is already under pressure, may come under more pressure and impact balance sheets adversely.”