New base rate math: Impact on aam aadmi and corporates

The Reserve Bank last Thursday announced a new base rate formula — moving toward marginal cost of funds methodology for interest rate on advances, which will be effective from April 1, 2016. This move is aimed at ensuring faster transmission of changes in RBI policy rates to banks' lending rates. But what does it mean for borrowers?

While this may seem beneficial to borrowers in a falling interest rate scenario, when rates go up, the increase too will be immediately passed on to borrowers.

A Business Standard report titled 'RBI's rate diktat cuts both ways' says the biggest impact will be felt by home loans borrowers because these are long-tenure loans. There will also be an impact on mortgage loans. Banks usually prefer to increase or decrease the tenure of the loan rather than tinker with interest rates. But in case of longer-tenure loans, the room to do so (especially increasing the tenure) is limited. In such a scenario, borrowers may have to pay higher EMI if and when RBI increases its repo rate.

But the impact on largely fixed-rate loans such as automobile and personal loans may be limited, and also in the case of hybrid home loans, where rates are partly fixed and partly floating, that on the floating portion should adhere to the MCLR guidelines, according to RBI, the BS report states.

But most experts feel the move toward MCLR will be beneficial to borrowers. The BS report quoting Gaurav Gupta of Myloancare.com says even if lending rates go up faster, the MCLR is beneficial because it is more transparent.

Giving more clarity, a Mint report titled 'What the lending rate math means for you', and quoting Ravikant Bhat, an analyst at IDBI Capital Market, says when the loan is on MCLR, the change in rates will be as specified in the loan agreement. "Once the MCLR is set, the borrower will have to pay the same interest rate till the reset date mentioned in the loan agreement. For instance, if the bank has given you a one-year reset period in your loan agreement, and your base rate at the beginning of the year is 9%, even if the interest rate comes to 8.5% in the middle of the year, you will continue at 9%," he told Mint. He also believes that at the end of the year, the benefit will come to the borrower only, but banks may reset interest rate more often than once a year.

Also on the positive side, with a move toward marginal cost of funds-based lending rate (MCLR), the growing trend of companies borrowing from the commercial paper (CP) market to meet their working capital requirements may get reversed, a Mint report titled 'New base rate rules may draw firms to bank loans' says. Banks believe they will be able to price tenor premium more accurately and hence bring down rates for shorter-term borrowings to levels rivalling those offered in the CP market. The Mint report says data from RBI shows borrowings through CPs have risen by Rs 1.3 trillion during April-November 2015, while incremental bank loan disbursements have been negligible.

Commercial paper (CP) are short-term — 12 months or less — unsecured promissory notes issued by companies to raise money.