Indian two thousand and five hundred rupee banknotes. (Photographer: Dhiraj Singh/Bloomberg)

Link Home Loans To Repo Rates, Says RBI Committee

The Reserve Bank of India-appointed committee on household finance has recommended that banks should link home loan rates to the central bank's benchmark repo rate. The committee, whose recommendations are not binding, suggests that this will allow for better and more transparent transmission of interest rates in the economy to individuals.

“Banks should quote loans to customers using the RBI repo rate rather than based on their own MCLR rates,” said the report released on Thursday.

According to the committee, this would make it easier for customers to compare rates at the time of purchase. The recommendations come at a time when the RBI has repeatedly chastised banks for not transmitting the full extent of rate cuts announced by the RBI. Earlier this month, RBI Deputy Governor Viral Acharya said that the marginal cost of funds-based lending rate (MCLR) system will be reviewed.

The committee suggests doing away with the MCLR entirely.

For prospective borrowers at the point of purchase, every floating-rate home loan should be quoted to prospective borrowers in the form of a market-wide standardised rate + spread as opposed to MCLR + spread.
Report of Household Finance Committee, 2017

Linking to the repo rate would be preferable since the it does not vary across banks, the committee added. Moving to a standardised rate + spread quoting convention will thus provide prospective borrowers with an immediate and useful benchmark for cross-product comparison, the committee added.

It also suggested that banks be asked to move to a standardised period over which loan rates are reset. This period should be one month, the committee said.

Under the current system, most floating rate loans are reset roughly once a year. “This may impede the monetary transmission mechanism, and not allow borrowers to immediately benefit from interest rate drops,” the committee noted.

For fixed-rate loans as well, the committee recommends that rates be quoted in reference to the repo rate.

While the borrower still has to compare the rate for the appropriate fixation period across banks, the universal quoting convention should facilitate easy comparison both along this dimension, as well as across fixed and floating-rate loans.
Report of Household Finance Committee, 2017