Explained: Why your home and auto loan rates should rise as RBI keeps the repo rate unchanged
The MCLR, which entered into force on April 1, 2016, is the minimum rate below which banks are not authorized to lend.
This week, SBI, Bank of Baroda, Kotak Mahindra Bank and Axis Bank raised their rates. This is the first time such a rise has occurred since 2019, implying that the soft rate regime that has prevailed for the past three years is coming to an end as India battles inflation.
“Since the onset of Covid, on a median basis, banks have cut their 1-year MCLR by 110 basis points, compared to 130 basis points cut in their 1-year deposit rates. As we expect As credit growth continues to improve and excess liquidity to reduce in the current year, we expect banks to raise their deposit rates, which will also lead to an increase in their MCLRs,” said Anil Gupta, Vice President and Co-Group Head, ICRA.
Interest rates have been low for several years. Now, both public and private sector banks have started raising lending rates, on the initiative of the SBI. This results in more expensive consumer loans like auto, home, and personal loans.
The SBI increased its MCLR by 10 basis points or 0.1 percentage point across all mandates, while the other three raised it by 5 basis points, or 0.05% across the board. As of April 15, SBI’s one-year MCLR is 7.1%, two-year 7.3% and three-year 7.4%. Axis Bank’s one-year MCLR as of April 18 is at 7.4%, two- and three-year at 7.5% and 7.55%, respectively.
“Since the start of 2022, banks have started raising the deposit rate. This is leading to a wider gap between lending rate and deposit rates. Inflationary pressure is also increasing and this will force RBI to raise the rate soon This move will further increase lending rates,” said Sucheta Mahapatra, general manager of the personal finance apps arm.
The story: The Reserve Bank of India (RBI) has issued guidelines on the calculation of interest rates on advances based on the lending rate based on the marginal cost of funds (MCLR) to banks by circular dated 17th December 2015. It came into force on April 1, 2016. It was introduced to help banks become more competitive and improve transparency in the pricing of loans.
“The increase in MCLRs is mainly due to two factors resulting from the general stance of less accommodative policy going forward by the RBI and the adjustment of the reverse repo rate. Considering the type of fluctuations oil prices and a sharp rise in the prices of other commodities, immediate control of inflation is apparently not possible and a hike in the repo rate by the RBI is expected soon. raised its term deposit rates in February to maintain its earnings spread, increasing the MCLR is a logical step,” said Jyoti Prakash Gadia, Managing Director, Resurgent India, an investment bank.
What is MCLR
“MCLR is a benchmark interest rate. A benchmark rate is the lowest rate at which a bank can lend. Lenders apply their mark-up on this benchmark rate to create a retail lending rate. For example, let’s say that a bank has an annual un-MCLR of 7.10 on which it applies a mark-up of 35 basis points, giving us a retail rate of 7.45.
The MCLR is a benchmark produced internally by banks. It is fixed for different durations ranging from one night to three years. Banks tie their deposit and lending rates to various MCLR durations. For example, a government bank compares its home and auto loan rates to its one-year MCLR,” says Adil Shetty, CEO of BankBazaar.
How is MCLR calculated?
MCLR is calculated based on the cash reserve ratio, marginal cost of funds, term premiums and the bank’s operating cost. If the cost of funds increases, the MCLR increases and loans tied to any MCLR term become more expensive. Likewise, if the MCLR goes down, your loans become cheaper.
How it works?
Bank loans issued between April 1, 2016 and October 2019 are all linked to the MCLR. Home loans issued after this date are linked to externally produced benchmarks, such as the repo rate. Borrowers have the option of refinancing their MCLR-linked loans into repo-linked loans, which are known to be more transparently priced and better pass on policy rate cuts, Shetty added.
What does the latest MCLR hike imply?
The latest spikes in MCLRs at various banks indicate that deposit and lending rates are about to rise. For MCLR-linked loan takers, the rate reset may occur as outlined in their loan agreement. Typically, MCLR home loans reset every six or twelve months.
Point to note: Under the MCLR regime, banks are required to adjust their interest rates as soon as the repo rate changes. Most economists expect the RBI to hike the repo rate by 25 basis points from the current 4% as soon as the June policy. Banks are already assuming that such a rise will happen, which is why several have increased their MCLRs. But this increase will only apply to variable rate loans and not to fixed rate loans.
What happens when rates rise?
Typically, in a rising rate environment, lenders maintain the same EMI and increase the term of the loan to account for the higher interest burden. However, for some long-term loans, such as home loans, where increasing the term may not be possible, lenders will also need to increase EMIs, which will increase the debt service burden for borrowers. “This could mean lower disposable income, which would negatively impact consumption and demand. Higher EMIs could also lead to higher delinquencies for lenders,” Icra’s Gupta said.
What should a borrower do?
Borrowers need to assess their situation to understand if it makes sense for them to stick with an MCLR-linked loan with the possibility of their reset still being months away, allowing them to benefit from lower rates for a bit longer. “If not, they can refinance at lower rates, increase their EMIs, or prepay their loans to mitigate the spike in interest rates,” Shetty said.
Why was the MCLR increased?
The increase in MCLR by various banks came after the Reserve Bank of India appeared hawkish as it focused on tackling inflation at the monetary policy review meeting held earlier in April. The MCLR rate hike comes after deposit rate hikes by banks in recent months.
One of the main reasons for the increase in MCLR is an increase in the block deposit rate by banks, according to Madan Sabnavis, chief economist at Bank of Baroda. “As new retail and domestic rates are now pegged to external benchmarks such as repo or 10-year G-sec, companies will largely see their borrowing rates increase.”
The proportion of MCLR-linked loans had the highest share of 53% in December 2021, even as the proportion of variable-rate loans linked to external benchmarks like repo rose to 39% in December from 29% in the end of fiscal year 21.
“As per the RBI report on monetary transmission in India, the share of MCLR-linked loans stood at 62.9% as of March 2021. Thus, an increase in interest would mean a heavier repayment burden for a substantial portion borrowers. said Adhil Shetty, managing director of BankBazaar.com.