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Will Repo Rate Linkage Finally Make Loans Cheaper? 

Borrowers faced the full brunt of rate hikes but rarely the full benefit of rate cuts. Repo-linked loans should end this. 

Customers wait to exchange rupee banknotes at a Syndicate Bank branch in Dadri, Uttar Pradesh. (Photographer: Anindito Mukherjee/Bloomberg)
Customers wait to exchange rupee banknotes at a Syndicate Bank branch in Dadri, Uttar Pradesh. (Photographer: Anindito Mukherjee/Bloomberg)

To understand the excitement around repo rate-linked loans, let’s take a step back to December 2018. In its bi-monthly policy review on Dec. 5, the Reserve Bank of India made the big announcement that retail loans will be linked to external benchmarks instead of various internal benchmarks produced by banks. The RBI said that banks had to start this linking from April 1, 2019, and also instructed them to adopt a single benchmark within its array of products in the same category of loans.

This meant that banks could no longer sell, for example, home loans linked to the marginal cost of funds based lending rate or base rate, in a scenario where they are linked to the repo rate. From the customer’s point of view, this was a tremendously helpful move from the RBI because the poor transmission of rate cuts from the central bank to the public has long been a matter of concern. By linking loans to an external benchmark and by maintaining a fixed credit spread through the tenure of a loan, banks will lose some of their control over the calibration of interest rates and will have to mandatorily transmit policy rate revisions to borrowers instantly.

But by March, only the State Bank of India had moved on the RBI’s directive. India’s largest public sector bank linked the interest rates of select deposit and overdraft accounts to the repo rate. As the months rolled by, no other bank announced the linkage of their rates to any of the three external benchmarks prescribed by the RBI. Through this period, the RBI continued to slash the repo rate: from 6.50 percent in January, four straight revisions brought it down to 5.40 percent by August. However, loan and deposit rates had not moved in tandem with these cuts.

In fact, during this period, some banks had maintained or even increased their deposit rates, in order to attract more inflows.

Impact Of High Deposit Rates

The RBI’s repo window is a smaller source of funds for banks compared to savings, current and deposit accounts which account for a large part of any bank’s inflows and cost of funds. Therefore, since the overall cost of funds weren’t coming down, interest rates remained sticky.

This phenomenon was visible in the rates of all banks. Let’s examine the rates offered by SBI. In the first week of January 2019, SBI’s highest fixed deposit rate was 6.85 percent on tenures ranging from three to five years. Its lowest home loan interest rate (for loans up to Rs 30 lakh) was 8.75 percent. Since January, the repo rate has reduced by a whopping 110 basis points. However, by Aug. 12, around a week after the RBI slashed the repo rate by 35 basis points, the SBI’s highest FD rate was still 6.80 percent on tenures ranging from one to two years. Its lowest home loan rate had reduced by just 40 basis points to 8.35 percent.

At this time, SBI had become the only bank to announce a new home loan product linked to the repo rate. Even as these adjustments happened, the overhanging concern remained: not enough of the policy rate cuts had passed to customers. RBI Governor Shaktikanta Das has been nudging banks to adopt external benchmarks. So far, some more public sector banks have announced their intentions to link to the repo rate. As per media reports, these banks include Bank of Baroda, Punjab National Bank, Union Bank, Allahabad Bank, and Canara Bank.

No private sector bank has so far taken this step. In fact, one publicly stated recently that there are many other ways to pass interest rate cuts to customers.
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Understanding The New Rate Math

At this point, we must also note what’s going on with SBI’s repo-linked loan. SBI linked this new home loan product to a new benchmark called the RLLR – Repo-Linked Lending Rate. The RLLR is composed of the repo rate over which there is a mark-up of 225 basis points. Upon the RLLR, there’s a credit spread calibrated as per the loan-to-value, customer’s credit score, the loan size and other parameters set by banks. The lowest credit spread on the loan currently stands at 40 basis points. In August, the RLLR was 5.75 percent + 2.25 percent = 8.00 percent, which was 25 basis points lower than the SBI’s MCLR. Currently, SBI’s lowest repo-linked rate for home loans up to Rs 75 lakh is 8.40 percent, which was comparable to their lowest rate on similar MCLR-linked loans. Now, here’s the critical bit. At the end of the month in which there’s been a repo rate revision, the RLLR is meant to revise automatically.

Since the repo rate fell from 5.75 to 5.40 in August, SBI’s RLLR will revise downwards to 7.65. With the spread remaining constant at 40 basis points, the lowest SBI home loan rate would, therefore, become 8.05 percent from Sept. 1, making this the cheapest home loan in the market.

The transmission of rates, in this case, is absolute, which wasn’t the case with even MCLR-linked loans which were started on April 1, 2016, to improve policy transmission. One of the achievements of the MCLR was making rate revisions mandatory at fixed intervals. For example, if you had an MCLR-linked home loan from a bank, it guaranteed automatic interest rate revisions at intervals—let’s say once every six months—mentioned in your loan contract. But even as the rate revisions were guaranteed, the quantum of the revisions remained low, some of the reasons for which are mentioned above. Now, with the RLLR-linked loan, this concern seems to have been addressed: its rate will reduce immediately by 35 basis points in a single revision, which is more palatable to borrowers than the same bank’s MCLR rate which reduced only 30 basis points through four different revisions since February.

How Borrowers Will Benefit

There is also some criticism of repo-linked loans. One is that they may lead to interest rate volatility, the brunt of which customers will bear once rates start to rise again.

However, there are multiple ways the customer can still see how a repo-linked loan works to his or her advantage.

  1. We’re currently in a low inflation period, and there are few triggers for an interest rate spike. Therefore, with rates falling regularly, a repo-linked loan will work to the borrower’s advantage.
  2. Customers are getting the full value for repo rate cuts. We’ve seen in the past that they get the full brunt of rate hikes but rarely the full benefit of rate cuts. Repo-linked loans should put an end to this.
  3. There’s no waiting around for policy rates to be passed to customers. In the case of the SBI’s RLLR-linked loan, customers will get their cut in less than a month of the repo rate revision, which is quicker than MCLR revisions.
  4. The RBI has mandated linking loans in one category to a single benchmark. Once this guideline is followed, we’ll no longer have to deal with multiple benchmarks, and also move past the era where existing customers continue to pay high rates while the lowest rates are reserved for new customers.

Of course, we’re making these assumptions based on one product launched by one bank, and we still need to see what the other banks do. If others follow suit, this can actually be immensely advantageous to the borrowers. The transition from one regime to the next has been slow and challenging. But let’s keep our fingers crossed.

Adhil Shetty is CEO at BankBazaar.com.

The views expressed here are those of the author’s and do not necessarily represent the views of BloombergQuint or its editorial team.