Banks should link home loan rates to repo rate: RBI appointed committee

A Reserve Bank of India appointed committee on Household Finance has suggested that banks link their home loan rates to the RBI's repo rate, the rate at which it lends to banks, instead of the Marginal Cost of Funds based Lending Rate (MCLR), which the banks follow now.

"Banks should quote loans to customers using the RBI repo rate rather than based on their own MCLR rates," the committee report chaired by Dr Tarun Ramadorai, Professor of Financial Economics, University of Oxford suggests. "To facilitate ease of comparison 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."

While these recommendations need not be accepted by the regulator, it comes when the RBI had hinted it was unhappy with the rate transmission under the MCLR regime. In the past three years the central bank has reduced the policy rate by 200 basis points, but the weighted average lending rates have fallen by 145 basis points. A basis point is 0.01 percentage point.

"The experience with the marginal cost of funds based lending rate or MCLR system introduced in April 2016 for improving monetary transmission has not been entirely satisfactory even though it has been an advance over the earlier base rate system," Viral Acharya, deputy governor RBI had said on August 2. "We have constituted an internal study group across several clusters to study various aspects of the MCLR system and to explore whether linking of the bank lending rates could be made direct to market determined benchmarks going forward. The group will submit the report by September 24th, 2017."

The committee has also recommended that all banks use the same reset period of one month for loans. Under the current system, floating rate loans have a fixation period of roughly one year. The report argues that the current system impedes monetary transmission mechanism and does not allow borrowers to immediately benefit from interest rate drops.

"If the bank decides to link home loans to the one-year MCLR, it should pass through any changes in the one-year MCLR rate to borrowers every month," the report says. “And if the bank decides to link home loans to the six-month MCLR, it should pass through any changes in the six-month MCLR rate to borrowers every month.

Source- ET Realty