Loan rates will come down

Over time, banks will be forced to either offer lower tenure fixed deposits or longer tenure floating deposits

For years, the Reserve Bank of India (RBI) has been nudging banks to reduce the interest rate on retail and micro, small and medium enterprise (MSME) loans. Finally, it has made it compulsory for banks to link all their floating rate loans to individuals and MSMEs to an external benchmark from October 1. The external benchmark can be the repo rate, or the three-month treasury bill rate, the six-month treasury bill rate, or any other benchmark market interest rate published by Financial Benchmark India Ltd. (FBIL). Currently, FBIL publishes at least 25 market-linked reference rates. 

Till now, banks have been reluctant to link rates to an external benchmark due to various issues like huge corporate non-performing assets, and high-interest rates being offered by competing deposits products such as public provident fund, postal fixed deposits, monthly income schemes, national savings certificate and others. In fact, State Bank of India did come out with a repo rate linked loan rate (RLLR) in August 2019, but the country’s largest bank’s website does not list it any longer. 

However, this step to link loan rates to an external benchmark is a significant step that is likely to change the entire banking landscape in the country. Let’s look at the interest rate that borrowers are paying currently if their loans are lin­ked to internal benchmarks (SBI’s loan rate data has been used for the analysis). 

Four borrowers with identical credit profiles have taken 20-year loans of Rs 30 lakh. The first borrower took the loan in June 2010 (original rate 8 per cent) and is currently paying 11.30 per cent; the second borrower who borrowed just a month later on July 2010 (original rate 8 per cent for the first year) is paying 10.80 per cent; the third borrower who took his loan in April 2016 (original rate 9.45) is paying 8.75 per cent, and the fourth borrower took the repo rate linked loan rate in August 2019 (original rate 8.40 per cent) is currently paying 8.05 per cent. So, borrowers with similar credit profiles are paying widely different interest rates – from 8.05 per cent to 11.30 per cent from the same bank. And this is a public sector bank. The situation is probably much worse for a borrower from a private sector bank. 

The linkage to an external benchmark will lead to more transparent pricing of loans, as any change in the external benchmark rate will reflect on the borrower’s rate, latest within three months’ time. 

Ok, so what is expected now? For one, banks are unlikely to choose the repo rate as the external benchmark. Over time, housing finance companies will also be forced to shift to an external benchmark rate linked loan due to competitive pressures. As usual, the small stock of aware borrowers will shift to the new lending regime. Most of the unaware borrowers will continue to pay a higher rate, as automatic shift to the new regime will not happen. Over time, banks will be forced to either offer only lower-tenure fixed deposits (such as one year), or longer-tenure fixed deposits on a floating rate basis. 

If you are planning to buy a home, wait until October 2019. The same applies to existing home loan borrowers planning to shift their loans from the old regime to the new one.

The writer is a Sebi-registered investment advisor