Thursday, March 28, 2024

Your home loans change from next year? Here’s what happens

Saturday, December 15, 2018, 5:47
This news item was posted in Business category and has 0 Comments so far.

RBI has mandated banks to use external benchmarks (e.g. treasury bill rates or repo rates) to determine interest rates on home loans from April 2019. Banks currently use an internal benchmark (bank’s own marginal cost of raising funds) to decide home loan rates. Will this move make the rates more transparent? Will rates become more affordable? Will the new system make rates more volatile? While banks are yet to come out with details, here are some basics of the proposed change:What is a benchmark in a home loan? What is the difference between an external and internal benchmark?Today 90% of the home loans are floating rates. Even when loans are given for 15 years, the interest rate is revised periodically depending on cost of funds for banks. A benchmark is a reference rate whose movement is reflected in the interest rate charged on the loan. Up till now, banks have been setting their own benchmarks. This started with the prime lending rate (PLR) and subsequently the benchmark prime lending rate (BPLR), which was followed by the base rate (BR) and more recently the marginal cost of funds lending rates (MCLR). An external benchmark is a reference rate that reflects cost of funds in the market, and is not decided by the bank.Will home loan rates come down with the new benchmarks?No. For new customers, banks can choose the interest rate. For instance, a bank can choose as a benchmark the repo rate — the rate at which RBI lends to banks — which is currently 6.5%. But it can price the loans at Repo rate plus 2.5% margin and give loans at 9%. But once a loan is disbursed, the bank has no control and the rate will be decided by the markets. For instance, since April 2014, the cut-off yield on the 91-day T-bill has fallen 209 basis points, while home loan rates for new customers have come down 135 basis points.
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What is the downside?At this point of time, linking to an external benchmark looks good because it has fallen more than the internal benchmarks. But there are periods in between when T-bill rates have shot up sharply much more than home loan rates, but in the long-term it all evens out. Those who check rates regularly might get confused because of the volatility.
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Why did the benchmarks keep changing?RBI cannot dictate the rate at which banks should give loans. But at the same time, it wants that when it cuts or increases rates, banks should make similar changes to their lending rates. This, it feels, is necessary for two reasons: the first is that it makes policy more effective by either curbing demand or stimulating it and, two, it ensures a fair deal for customers. To ensure that this happens, RBI wants the benchmark rate to reflect current market rates. But banks can manipulate their cost of funds as this depends on each bank’s strategy. To ensure a fair deal for all, RBI has asked banks to use an external benchmark from April 1, 2019.How does an external benchmark help customers?A new customer has the flexibility to choose from the market. This is why banks offer their best rates to new customers. Banks can discriminate between new and old customers by tweaking the benchmark to make them more sticky and offer new customers cheaper rates by reducing the spread. Unlike internal benchmarks, external ones are expected to be more fluid and float both ways.Which are the external benchmarks that are available?Banks can choose from the policy repo rate, the yield on the 91-day Treasury bill or the 182-day Treasury bill or any other benchmark rate produced by the Financial Benchmarks India (FBIL). The treasury bills are debt issued by the government and considered to be a good reflection of cost of funds because there is no credit risk and there are always buyers of this bond. The FBIL is a body promoted by Fixed Income Money Market & Derivative Association of India (FIMMDA), Foreign Exchange Dealers’ Association of India (FEDAI) and Indian Banks’ Association (IBA).

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