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Floating Rates (MCLR) and Fixed Rates: Is Benchmarking Alone Enough

By Finserv MARKETS - Sep 11,2019
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Floating Rates (MCLR) and Fixed Rates: Is Benchmarking Alone Enough

As per the to the new guidelines set by the Reserve Bank of India (RBI), all new floating-rate loans including are linked to external benchmarks since April 1, 2019. The benchmarks include either RBI’s policy repo rate, 91 days Treasury bill, 182 days Treasury bill, or any other benchmark of the Financial Benchmarks India Private Ltd. These benchmarks are market-linked and will change more often than your Marginal Cost based Lending Rate (MCLR) that banks and other financial institutions are using currently.

Floating interest rate

  • Floating rates are levied based on MCLR rate plus a spread.
  • This spread will remain the same throughout the life of the loan unless the borrower’s credit valuation undergoes a substantial change as mentioned in the loan contract.
  • This spread over the RBI MCLR rate will be decided by the bank.

Fixed interest rate

Approximately one fifth of scheduled commercial banks continue to offer credit at fixed rates (public sector banks, or PSBs — 15.27%, private banks — 26.47%, and foreign banks –- 34.5%) and therefore, this ‘segment’ won’t have much impact on new benchmarking.

Impact of loans linked to external benchmarks

  • Now, since the interest rates will be linked to the benchmarks, they are going to reflect market rates very quickly. Therefore, at the time of repayment of the loan, you will be paying more in interest sooner rather than later.
  • As these benchmarks are market-linked, they are going to be highly volatile. Therefore, RBI has to allow a reset frequency that is different from these benchmarks. Even a 3 or 6 months reset frequency can affect your EMIs heavily.
  • Another point to be noted is that the benchmark rate system is only applicable if you are borrowing from banks. RBI hasn’t made any comment about rates set by NBFCs and other HFCs. Therefore, you will have to compare rates across the board in order to avail the best rate for your loans.

More clarity is needed regarding how the benchmark rate will be calculated. Will it be an average of the rates during a period or the rate at the end of a specific period? Given the volatility of these benchmarks, it is more likely that the benchmarks would be an average of the rates. But that period has to be long since loans are taken for long terms and regular changes in loan EMI or term will create problems for the borrower.

This year, the Treasury bill (T-bill) rates have risen faster than the repo rate and the MCLRs of banks. Therefore, if the loan rate is linked to the T-bill rate, you might have to pay a higher interest even before RBI actually hikes interest rates.

Therefore, if you are looking for a house loan, this might be the right time because the interest rates are going to increase significantly. Moreover, you can take advantage of the Pradhan Mantri Awas Yojana (PMAY) subsidy that has been extended till 31st March 2019. You can consider availing a Bajaj Finserv home loan to finance the purchase of your dream house.

If you are an existing home loan borrower looking for better interest rates, it is recommended that you should wait until RBI clarifies how the new benchmark system will work.

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Bajaj Finserv Direct Limited ("BFDL"), erstwhile Bajaj Financial Holdings Limited is a registered corporate agent of Bajaj Allianz Life Insurance Company Limited and Bajaj Allianz General Insurance Company Limited under the IRDAI composite registration number CA0551 valid till 10-Apr-2021. BFDL also renders services to Bajaj Finance Limited (‘BFL’) and Bajaj Housing Finance Limited (‘BHFL’) (referred hereinafter as ‘Lending Partner’) in sourcing of customers, providing preliminary credit support activities, fulfilment services and post-acquisition customer services related to lending business. Registered Office: Bajaj Auto Limited Complex, Mumbai – Pune Road, Akurdi, Pune – 411 035 CIN: U65923PN2014PLC150522