5 Things To Know About New Loan Rate

The RBI announced an increment in the repo-rate from 6.0% to 6.25% on 6 June for the financial year 2018-19. For the first time in the country, the rate was raised for the second time in a single year. The repo-rate was revised again on 1st August 2018. The repo-rate now stands at 6.5% and the reverse repo rate has also increased by 25 basis points to 6.25%. The Marginal Standing Facility (MSF) Rate and the Bank Rate have also increased from 6.50% to 6.75%.

Since MCLR estimates every kind of loan rate except for personal loan, the loans are estimated to grow cheaper, including auto, home, and personal loans.

Top Five Things to Learn about the RBI New Loan Rate

In a move to enhance the interest rate regime, the RBI launched the MCLR which aimed at drawing more transparency and regulations in the banking system of the country. MCLR is the Marginal Cost of Funds that is based on the lending rate which is a remodeled version of the base rate system. The question in everyone's mind is how it can affect ordinary people. Discussed below is how MCLR can change the way banks lend money, current loan and, future loans.

What is the need for a New Loan Rate?

Under the traditional system of base rates, periodical changes in the rates were introduced by the Reserve Bank of India. This, in turn, needs to be introduced by the banks supporting their lending rates schedule. But in reality, banks were hesitant to change their deposit and lending rates. Reports show that when RBI raised the rates, banks retaliated by increasing their rates as well. But when RBI reduced the rates, the banks took a longer time to adjust their rates. Hence the need for a better system arose. The RBI executed the new MCLR method in April 2016. Under this system, the banks are obligated to update their rates on a regular basis. This ensured that they could keep pace with the changes in rates prefaced by the RBI.

Understanding MCLR

MCLR could seem like a complicated concept but, it becomes much simpler to understand if you break it down. In economics, marginal refers to the marginal change in the cost. MCLR is based on the Marginal Cost Condition. The components that make up marginal costs include:

• The marginal cost of funds comprises of the marginal cost of borrowing and returns
• The operating costs incurred by banks
• The negative carry on account of cash repo rate. The negative carry on account refers to the expenses that the banks incur for maintaining their cash reserves with RBI
• Tenor Premium is the higher interest rate that the banks charge on long-term loans

MCLR Calculations

Marginal costs are charged based on these factors, as per the guidelines of RBI:

• Borrowings include the repo rate, short-term interest rate and, long-term interest rate
• The rate offered on deposits like savings, foreign currency deposits, current deposits and term deposits
• Return on net worth

Marginal Cost of Funds is based on these components:

• 92% of the MCLR is estimated by the marginal cost of funds, repo rate and, deposit rate. The return on the net worth will be 8%.
• The MLCR is estimated based on the interest rate that is granted by a bank on repo-rate and deposits.
• From the calculations of MLCR, the base rate is derived.
• The MCLR is revised on a monthly basis while taking into consideration the repo-rate and other rates linked with borrowings.
• Based on MCLR, the bank is required to fix the interest rate for the various type of customers depending on the risk factor involved.
• The recent guidelines help the commercial banks to provide the new benchmark lending rates based on Marginal Cost of Funds.
• Five benchmark rates are declared for various tenures ranging from 1 day to 1 year.
• For tenures exceeding one year, the banks have the freedom to set the rates.
• Banks aren't allowed to lend below MCLR but, there are a few exceptions.

Banks are allowed to lend below the MCLR under these conditions:

• Loans granted against deposits
• Loans extended to the employees of the bank
• Loans associated with MCLR

How can MCLR affect your loan?

If your current loan is based on a fixed interest rate, then MCLR won't apply to you. The MCLR will be fit for all the floating rate loans which are sanctioned from April 1st, 2016. In cases of credit renewal, MCLR comes into effect. Present borrowers can shift to the MCLR system if they want. MCLR-linked loans include:

• Auto loans
• Home loans
• Educational loans
• Loan against Property
• Corporate term loan

If you have borrowed your loan from an NBFC, MCLR is not applicable. MCLR pertains only to banks.

How does MCLR-linked loan works?

Loans linked to the MCLR system function differently. To know how MCLR-linked loan works, we need to first understand the terms reset clause and spread.

When someone applies for a loan, the MCLR prevailing on the date of sanction is applicable on loan. The reset date is allocated which is usually one year. The reset tenure is lesser based on the agreement with the bank and, on the reset date, the interest rate is changed to the rate that is prevailing on that particular date.

MCLR linked loans are always linked to a spread. Spread is an amount that is charged by the banks over the MCLR. The banks are allowed to have an interest rate that is 25 basis points above the MCLR. Banks are free to set an interest rate which varies up to 25 basis points over the MCLR.

What does MCLR mean for Subsisting Loan Borrowers?

Borrowers who have an existing loan sanctioned by a bank have the option to resume under the base rate system or they can switch to MCLR. If the borrower prefers to switch over to the MCLR scheme, they can't go back to the rate base system. You need to follow these steps for changing your loan to MCLR:

• You'll be required to request the bank to link your loan to MCLR and to reduce the quantum of your spread.
• For the conversion, there could be a single-time fee applicable that must be paid by you.
• To find out if shifting to MCLR is worth it, you will be required to take into account the fees that are payable, the remaining tenure and whether the revised interest rate is profitable. You can use an EMI calculator which is available on most of the official websites of banks to find out the amount of EMI payable. If transforming to the MCLR regime means that you are benefitted by 25 basis points or more, and you have a long tenure left, then the change might be a wise decision. If shifting only means the difference of 10 or lesser basis points, and if your loan is short-term, then it is better to stick to the current regime.

Effects of MCLR

Transparency

MCLR brings a sense of transparency. Customers who follow MCLR are aware of the changes in the interest rates and the reasons behind the changes.

Interest Rate

With the base rate system, RBI perceived that the banks were extremely slow while cutting their rates when the RBI slashed the repo rate. On the contrary, when RBI raised rates, the banks immediately increased their rates as well. The MCLR scheme endeavours at changing this particular situation and adjust the interest rates of banks more frequently according to the cost conditions.

Reset Clause

Reset clause brings a necessary periodic revision of the interest rate of the loans.

Spread

Banks initially offer loans with a low-interest rate and low spreads. But as the tenure progresses, the banks increased the spread for no particular reason. This was an unfair practice that was prevalent in the banking system, and it affected the customer's loan negatively. Under the MCLR system, banks should set a spread on the loan that has been sanctioned. The spread is changed only when the profile of the borrower changes.

Regulations on banks

Banks are now limited on the quantum of spread that they can charge during the loan tenure. Banks are also obliged to publish the current interest rates on a monthly basis for at least five tenures.

Exemptions under MCLR

• MCLR doesn't apply on Fixed rate loans. For instance, if your home loan has a fixed interest rate, then MCLR doesn't apply to you.
• Only the banks are allowed to follow the MCLR regime and loans taken from NBFCs don't follow under this regime.
• Loans that are under the purview of government schemes are exempted from MCLR since the interest rate is set by the government in those cases.
• The MCLR allows the RBI to streamline interest rate

The MCLR is intended at bringing a better system which guarantees fair practices and generous loan terms for the customer.