What happens to loan rates when banks hike MCLR? 5 key questions answered

Retail and corporate consumers opting for a bank loan are bracing for higher loan rates in the coming months after key lenders started raising their key reference lending rates or the so-called marginal cost of fund-based lending rate (MCLR). State Bank of India (SBI), the country’s largest lender, increased its MCLR by 10 basis points across tenures, effective April 15. Peers like Axis Bank, Kotak Mahindra Bank and Bank of Baroda have also upped their MCLRs recently.

What is MCLR?

MCLR is an internal reference rate for banks set by the Reserve Bank of India (RBI) to help determine a minimum interest rate on various types of loans. The final rate of lending will also include risk premium and spread charged by banks. To simplify further, MCLR is the minimum rate at which banks can offer loans to end-consumers. The MCLR method was introduced by the RBI in 2016 to help borrowers avail various loans, like home and auto loans, and enable a smooth transmission of the central bank’s repo rate.

The repo rate is the rate at which RBI lends funds to banks.

How does hike in repo rate affect banks’ MCLR?

Under the MCLR regime, banks typically adjust their interest rates as soon as the repo rate changes. With retail inflation persistently high, mainly due to the surge in commodity prices, most economists are expecting the RBI-led Monetary Policy Committee to hike the repo rate by 25 basis points (bps), from 4 percent now, as early as the June policy. One bps is one hundredth of a percentage point.

Assuming the probability of such a hike, banks are hiking their MCLRs. However, this hike will be applicable only on floating rate loans and not on fixed interest rate loans.

Will external benchmark-linked lending rate (EBLR) also rise if repo rate is hiked?

External benchmark-linked lending rate (EBLR) is a system parallel to the MCLR regime, in which banks peg the lending rate to a benchmark like repo rate or Treasury Bill rates. Hence, if the repo rate is hiked, it could lead to a consequent increase in EBLR as well, making loans costlier.

If the MCLR or EBLR is hiked, how will it impact borrowers?

Clearly, when banks hike MCLR, new borrowers will have to shell out more to service their auto, home, vehicle, and personal loans and will consequently see their equated monthly instalments (EMIs) rising in the coming months.

According to Adhil Shetty, chief executive officer at Bankbazaar.com, borrowers should prepare for a gradual increase of 100 bps on their loans for this financial year that began April 1, if inflation continues to harden.

What can borrowers do to combat the impact of higher MCLR?

According to analysts, borrowers could either increase the tenure of the loan to reduce the EMI or make part pre-payment of such loans to bring down the EMI.

“Typically in a rising rate environment, lenders keep the EMI unchanged and increase the loan tenure to account for higher interest burden,” said Anil Gupta, vice president and sector head, financial sector ratings at ICRA. “However, in the case of home loans, where increase in tenure may not be possible, the lenders will have to increase the EMIs also, which will increase the debt servicing burden for the borrowers.”