While Union Bank customers will see rates go down 10 bps, there needn’t be a correlation for other lenders.
State-run Union Bank of India’s rate cut should make its home loan borrowers happy. Though the cut is small — just 10 basis points —this is the first time borrowers will see a downward revision in rates in almost two years.
The decision surprised many. However, M V Nair, chairman of UBI, says "We reviewed the components of the base rate and decided to pass on the benefit to customers. Overall, the Reserve Bank of India (RBI) has given an indication that interest rates may not be raised any more, and there is a possibility of these coming down in the future. The lower credit offtake was also a reason to reduce the base rate."
| THE BASE RATE EFFECT |
|
What is better news is that the entire cut will be passed on to borrowers. And, if one goes by the RBI's indications, there could be more rate cuts on the anvil if the apex bank signals/cuts its key rates.
Says S Govindan, general manager, personal banking & operations of UBI: "It is an automatic system. Customers are directly impacted as soon as the base rate comes down."
While Union Bank has passed on the entire rate cut benefit to borrowers, this may not be true for other banks. A section of the industry doubts the extent to which a cut in base rate can be passed on. Many banks may tinker with your spread above the base rate, not passing on the entire benefit. "This will largely depend on the asset-liability condition of banks and the cost of funds. And, the latter has not eased. Hence, banks may decide against passing on the entire benefit to customers," said a public sector banker. The spread is also decided on the basis of borrower's credit profile, employer, income level, loan to salary ratio and so on.
Here's how banks can do this. Say you are repaying at base rate plus two per cent. If the former is 10 per cent, your borrowing cost is 12 per cent. Assuming your bank brings down the base rate by 50 bps, your borrowing cost should become 11.5 per cent. However, your bank could play with the spread and say it is is revised to base rate plus 2.5 per cent from now. In effect, not passing on any benefit to you or passing on just 25 bais points.
However, experts say that in the prime lending rate (PLR) regime, loan rates were much stickier. Harsh Roongta of apnapaisa.com agrees that banks do tinker with the spread. Banks would raise rates but when it came to lowering these, they were much slower.
Shifting to a base rate regime, from that perspective, may make much more sense.
In this regime (introduced in 2010), the floating rate of interest on housing loans are calculated by adding a pre-decided margin or spread to the bank's current base rate.
While customers who borrowed before the base rate came into existence may not benefit significantly, financial experts make a strong case for it simply because when rates fall, there will be at least some benefit that is passed on. For instance, if you had borrowed in 2006-07, you are most likely to be paying near 13 per cent today. If you decide to shift to base rate and the bank's is 10 per cent, they will give you a loan at the base rate plus 300 basis points, thereby keeping your rate of interest the same. However, in the future, if the base rate falls, you are likely to benefit. Bankers argue it isn't possible to offer the current rate of 11 per cent to those who were paying 13 per cent because the cost of funds while disbursing the loan was higher. But a reduction in rates is possible in the future.
Adhil Shetty of BankBazaar.com says,"There is no fixed formula to come to a rate when you shift from the PLR to base rate. Hence, the time taken to get the benefit will be more. The best way out for customers is to refinance their loan." This option has become quite attractive, now that most banks have waived the prepayment charges, even if shifting loans.
