The face of the Indian Home Loan Industry has been changed a lot in the past few decades. From the digital tools to various government schemes supporting borrowers and lenders, the entire home loan process has become more simplified than it was in the past. From the last few years, banks were using the Marginal Cost of Funds based Lending Rate (MCLR) to decide the interest rates on home loans. However, recently Reserve Bank of India (RBI) has taken a big step and made it mandatory for banks to use the external benchmark lending rate to decide the interest rates on retail and home loans.
In 2017, RBI formed an Internal Study Group (ISG) to evaluate the effectiveness of the MCLR system. In October 2017, ISG submitted their study stating that MCLR was not effective in terms of monetary policy. So, they advised RBI to switch MCLR to an external benchmark for the effective transmission of monetary policies.
As a result, it was announced that all new floating rate personal or retail loans provided by banks from April 1, 2019, shall be linked to external benchmarks. However, in April 2019, another announcement was made. According to this announcement, officials were going to have further consultations with stakeholders in order to design an effective mechanism for transmission of rates.
After the consultation with stakeholders, it is has become clear that all new floating rate personal or retail loan including home loan, car loan etc. as well as floating-rate loans to Micro and Small Enterprises provided by banks after October 01, 2019 will be linked external benchmarks. Banks are instructed to use one of the following benchmarks,
- Repo Rate
- 3 months treasury bill
- 6 months treasury bill
- Other benchmark published by FBIL
Banks are free to select any of the above benchmarks and link it to the home loan interest rates and other retail loan interest rates.
Previously, the borrowers had to wait to get the benefits of RBI cutting the repo rate due to the reset clause of the MCLR system. But with an external benchmark, the interest will be reset at least once in three months. As a result, borrowers can experience the benefits of RBI cutting repo rate.
Moreover, RBI has mandated banks to use uniform external benchmark within loan category in order to ensure standardization and transparency. This means, one bank cannot use more than one benchmark within a loan category.
Smriti Jain is the owner and senior content publisher at Financesmarti. Financesmarti is a website where she shares a lot of useful stuff for the people and business of India. This includes small business ideas and other banking information, as well. Smriti completed her education in science & technology from Delhi University. Smriti usually has interests in digital marketing now, and she has chosen this career for the full-time opportunity. The primary purpose of starting this blog to provide quality information on the banking industry to the people.