New norms for pricing loans, may lower interest rates

From Times Property

In the last monetary policy review, the Reserve Bank of India (RBI) left the key interest rates unchanged. This was more or less on expected lines. The RBI has already reduced the policy rates a number of times during the last one year. It has lowered the repo rate by 125 basis points since last January.The RBI has been asking banks to pass on more of the benefits to borrowers, and there may be some more interest rate reductions now. This will be due to the new system of pricing of loans introduced by the RBI, and is expected to be operational in the near future.

The RBI has revised the lending rate norms effective April 2016. Lenders will calculate their lending rates based on the marginal cost of funds, or the rate offered on new deposits. The new rule will make loans cheaper for prospective borrowers. The RBI has now asked banks to fix lending rates benchmarked against the marginal cost of funds-based lending rate (MCLR). Under the new method, the latest rates offered on a deposit or borrowing is taken into account. RBI has allowed banks to have different MCLRs for different tenures.

Banks currently set their lending rates based on the average cost of funds on deposits outstanding. Under the new norms, they will have to price loans with reference to the MCLR. According to the new rule, every bank will be required to calculate its marginal cost of funds across dif ferent tenures. To this, the bank will add other components including operating costs and a tenure premium. A tenure premium is the compensation for the risk associated with lending for a longer time. Taking all these components into account, a bank will publish its MCLR for loans.

This MCLR will act as the minimum or base lending rate for that tenure of loans irrespective of the borrower. The final lending rate will be the MCLR plus the spread that a bank will charge for individual categories of borrowers. Banks will have to calculate their cost of funds under the marginal cost of funds method. This will ensure a deposit rate increase or decrease immediately reflects on the bank’s cost of funds, and hence on its lending rates.

The MCLR is a tenure-based benchmark rather than a single rate. As such, it will allow banks to price loans more competitively based on different MCLRs. Under the new method, a bank will have to manage its asset-liability mismatches to reduce volatility in earnings, and accordingly will be able to charge different rates of interest on loans. Banks having a larger share of low-cost deposits will be able to charge lower interest rates.

So, prospective borrowers can expect some more action on the interest rate front in the next couple of months, consequent to these recent changes initiated by the RBI and how they impact the pricing models of banks. Prospective borrowers can expect some more interest rate reductions in the coming months thanks to these changes.

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