Will RBI’s new base rate guidelines help borrowers?

The much-awaited Reserve Bank of India (RBI) guidelines on calculating the benchmark lending rate are finally out. In yet another attempt to make banks pass on policy rate cut benefits to borrowers, the RBI has brought out a new methodology: Marginal Cost of Funds based Lending Rate (MCLR). Marginal funds refer to money raised by banks in the last month or quarter before the lending rate review. The new methodology will come into effect from 1 April 2016 and is expected to curtail banks' ability to hold on to higher base rates despite the RBI slashing rates.

How it works

So far, banks followed diverse methodologies for computing the minimum rate at which they could lend—the base rate. Now, the RBI has asked all banks to follow the marginal cost of funds method to arrive at their benchmark lending rate. MCLR will be calculated after factoring in banks' marginal cost of funds (largely, the interest at which banks borrow money), return on equity (a measure of banks' profitability), negative carry on account of cash reserve ratio (the cost that banks incur on account of keeping reserves with the RBI), operating costs and tenure premium (longer the loan term, higher the interest/premium).

The actual lending rate will be MCLR plus the spread determined by banks after taking into account their business strategy and credit risk of the borrower, among other parameters.

Banks can review MCLR once a quarter till March 2017, after which they will have to publish the MCLR on a monthly basis. Lenders will also have to specify the interest reset dates on their floating rate loans. They can either grant loans with reset dates linked to the date of sanction, or the date of MCLR review. The Home Loan Interest Rates charged to a borrower will be applicable until the next reset date. The gap between two reset dates cannot be longer than a year.

Core benefits

The RBI expects the new formula to make floating lending rates more responsive to its policy rate cuts. Ratings agency ICRA believes that the norms will improve policy transmission for new borrowings. "(MCLR) will impact new borrowers immediately: they will benefit in a declining interest rate scenario and take a dent when interest rates are rising," says ICRA. Even existing borrowers will have the option to switch to MCLR when it is introduced.

[Source: http://economictimes.indiatimes.com/wealth/borrow/will-rbis-new-base-rate-guidelines-help-borrowers/articleshow/50330944.cms]