No Rate Relief For Existing Borrowers Even As Banks Cut Rates

Bank lending rates are finally falling. At least that is what banks are telling us. But if you haven't seen a drop in your EMI (equated monthly installment), read on.

A number of large lenders have announced a reduction in loan rates in recent days across products like home loans as they try and capture festive season demand. Banks have also cut their marginal cost of fund lending rates (MCLR) - a new interest rate framework introduced earlier this year.

There is a catch. A large part of the existing loans are still linked to the old base rate system, where the drop in rates has been slower. While banks give customers the option to switch their loans from base rate to MCLR, they charge a hefty fee of between 0.5-1 percent of the outstanding loan.

The result - relatively few borrowers are benefiting from the recent drop in rates.

According to Nitin Kumar, a fundamental analyst at brokerage firm Prabhudas Lilladher, a significant proportion of borrowers may not be benefiting as their loans remain linked to the old base-rate system rather than the MCLR. “For one large private sector bank, only about 15-20 percent of its retail book is priced according to the MCLR (marginal cost of funds lending rate),” he said while declining to name the bank.

A senior official at IDBI Bank, on condition of anonymity, agreed that a large portion of the bank's retail book is still pegged to the base rate. While ICICI Bank did not share the proportion of borrowers who have shifted to the MCLR, Chanda Kochhar, as part of the bank's earnings press conference, said that the option is available to all borrowers.

Emails sent State Bank of India and Axis Bank asking for details were not answered.

Why Old Loans Are Costlier

The crux of the matter is that the reduction in the base rates has not kept pace with the reduction in the MCLR. With the recent 10-15 basis point cut in MCLR by State Bank of India and HDFC Bank, the gap between the two rates has only widened.

A basis point is one hundredth of a percentage point.

In April this year, the RBI introduced the marginal cost of funds method for calculating lending rates because it felt that banks were taking too long to transmit lower rates under the base rate system. While a change in rates under the base rate mechanism was linked to the average cost of funds, the MCLR is calculated based on the marginal cost of funds.

Since the start of this fiscal, the larger banks have cut their MCLR by 10-30 basis points. SBI's benchmark lending rate, after the most recent cut of 15 basis points, stands at 8.90 percent, while that of ICICI Bank is at 8.95 percent. HDFC Bank, on Monday, reduced its MCLR by 15 basis points to 8.90 percent, matching SBI.

Among the other public sector banks, Punjab National Bank, Canara Bank, and Union Bank have cut their MCLR by 15 basis points each. Private sector banks, such as Axis Bank, Yes Bank, and Kotak Mahindra Bank have reduced their MCLR by 10-35 basis points.

A number of these banks, however, have not reduced their base rate by the same proportion.

When the shift to MCLR happened, the RBI stipulated that borrowers who took loans before April 1 would continue to pay the rates determined by the base rate. They would, however, have the option of shifting to the MCLR determined rate at an agreed fee.

What It Costs To Shift To MCLR?

In order to shift from a base rate-linked loan to an MCLR-linked rate, a borrower would have to intimate the bank and then pay a one-time fee worth 0.5-1.0 percent of the outstanding loan amount, said Arnav Pandya, a certified financial planner.

“The bank providing MCLR rate considers the transferred loan as a new loan. Hence, the processing fee will be similar to a new loan, which is 0.5-1.0 percent of the outstanding loan amount,” said a spokesperson of online loan marketplace BankBazaar.

For borrowers who have not sought a shift to the MCLR-linked rate, assuming they opted for a floating rate, the rate of interest on their loans, would continue to be pegged to the base rate.

According to Pandya, a lot of retail borrowers have not shifted to MCLR from the base rate calculation because they're simply unaware of the distinction.

“Customers will have to be proactive in this case, because banks will not simply pass on the benefit,” said Pandya. “As an existing customer there are two things you can do: one you can shift to the MCLR by paying the one-time processing fee stipulated by the bank, and two, you can get another loan and pre-pay the existing one.”

Between the two options, Pandya said the first option would be preferable. He said the 30-basis-point gap between the two rates would make a huge difference to the final payout, especially if the remaining amount of the loan is large. This would make it very beneficial for customers to shift to the new calculation method, he said.

Customers may also have the option to negotiate a lower spread over the base rate for their individual loan if they are not keen to switch to an MCLR-linked loan, said Kartik Jhaveri, director at Transcend Consulting, a financial planning firm.

Transmission To Continue In Dribs And Drabs

“Initially transmission lagged, but the pace appears to have picked up because the cost of deposits has reduced,” said NS Venkatesh, executive director at Lakshmi Vilas Bank. “The credit cost in the banking system is still high. And the component of fixed deposits is also much higher. It's 65-70 percent of deposits, so the cost of funds will come down only slowly.”

The larger banks have transmitted more than the smaller banks, according to Venkatesh. He explains that smaller banks have a lower proportion of current account and savings account deposits which means they are sitting on costlier fixed deposits.