State-owned lending major Bank of Baroda (BoB) has cut its repo-linked lending rate (RLLR), to which its home loans are pegged, by 15 basis points to 8 per cent with effect from March 1, 2020. The revised rate will be applicable to home loans sanctioned after this date. However, existing RLLR home loan borrowers – who have taken fresh loans or opted for a balance transfer after October 1, 2019 – will not benefit from the move.
“We have reduced our mark-up (or spread) over repo rate from 300 basis points to 285 basis points,” said Virendra Sethi, head, mortgages and retail assets, Bank of Baroda. “Our operating costs have come down and hence the bank has decided to pass on the benefits to borrowers.” A basis point is 0.01 percentage point. The effective interest rate for borrowers is the repo rate plus a spread specified by the bank, which includes operating cost, besides a credit risk premium.
RBI’s rate cut push
This reduction comes close on the heels of the Reserve Bank of India’s decision to grant cash reserve ratio (CRR) exemption to banks for certain retail and small & medium enterprises (MSME) loan segments. The announcement, made during its monetary policy review last month, specified automobiles and residential housing as the eligible retail loan segments for the purpose.
The move allowed banks to deduct an amount equal to the incremental loans disbursed to these segments between January 31 and July 31 from their net demand and time liabilities (NDTL).
CRR is the cash amount that banks have to mandatorily park with the RBI, but fetches no interest. The CRR exemption for these segments, valid for up to five years, would therefore free up resources for banks. This, in turn, will bring down the cost of funds and encourage banks to lend more to these segments. The aim was to get banks to transmit the benefits to customers. On cue, some banks, including BoB, reduced their marginal cost of funds-based lending rates (MCLR) by up to 10 bps soon after the announcement.
RLLR, however, had been left untouched, until now. “All new borrowers will benefit from this (BoB’s RLLR revision) move. However, existing borrowers are insulated from adverse/favourable movement of mark-up for three years. As the spread in a loan contract can be altered only once in three years, the existing RLLR borrowers will gain from the move at the time of mark-up reset," explained Sethi. On the other hand, the RBI slashes the repo rate, the benefit will be passed on to all borrowers – existing as well as new – on the subsequent quarterly reset date.
Loan rates linked to benchmarks
Since October 1, 2019, all banks have had to mandatorily link their new floating-rate retail loans to an external benchmark – RBI’s repo rate, three/six month treasury bill yields or any other benchmark prescribed by Financial Benchmark India Private Ltd (FBIL). The objective was to ensure effective RBI policy transmission and greater transparency. A long-standing grievance of home loan borrowers has been their banks’ unwillingness to pass on benefits of a policy rate cut, while being prompt in raising rates in line with hike in policy rate. Step-motherly treatment meted out to existing borrowers is another grouse – newer borrowers are often offered comparatively lower rates. The new system was seen as antidote to such complaints. “However, if banks can revise RLLR only for new customers, without passing on the benefit to existing customers, it somewhat defeats the purpose of the external benchmarking regime,” says Vipul Patel, Founder, Mortgageword, a loan consultancy firm.
Under the new regime, banks have to reset their external benchmark-linked lending rates once in a quarter. The spread, which includes operational cost, can only be altered once in three years. Credit risk premium, though, is more dynamic – it will be revised if there is a substantial change in the borrower's credit profile. Most banks, except Citibank, have zeroed in on the repo rate as their benchmark.
If you borrow from BoB, and if your credit score is over 725 – signifying high creditworthiness – the rate applicable will be 8 per cent. That is, repo rate (5.15 per cent currently), plus a mark-up (285 bps). For those with lower credit scores, a credit risk premium of up to 100 bps will come into play.