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What borrowers should know about Base Rate, MCLR and External Benchmark Lending Rate

In the year 2010, the Base Rate System was introduced in the Indian Banking by the Reserve Bank of India. A few years later, in the year 2016, the MCLR system replaced the Base Rate System intending to boost transparency in fixing the interest rate.

The interest rate banks charge consists of several variables such as bank’s spread, current financial status, non-performing assets, etc. Thus, due to the dependency of interest rate on these internal benchmarks no significant change was introduced on the interest rate charged by banks despite the announcement of RBI repo cut.

Hence, to bring more robustness and transparency in the Indian financial system RBI has directed banks to implement an external benchmarking system from 1st October 2019 onwards. As per the RBI mandate, all floating rate loans together with retail loans and loans sanctioned to MSMEs will levy interest rates according to the external benchmark system. Nevertheless, banks will have the freedom to sanction external benchmark linked loans to other types of loan borrowers as well. Additionally, they can also decide the Spread to be charged on a particular loan. While banks must reset interest rates under an external benchmark once every three months.

Due to external benchmarking of loans, borrowers can enjoy the benefit of faster rate reduction in events of policy repo rate cut decisions.
Existing borrowers can opt to switch to a new external benchmarking system by requesting the concerned bank branch. The conversion can be done without any additional charges; however, there are some administrative and legal charges that you need to pay as per your loan type.

To calculate credit risk premium banks assess the borrower’s credit report. The credit risk premium is subject to change only when the borrower’s credit assessment goes through a considerable change, as consented in the loan agreement.

During shortfall of funds, banks borrow money from RBI on which they are charged a certain interest rate. This interest rate is referred to as the repo rate.

Alternatively, during excess liquidity RBI borrows money from banks for which it pays banks a certain interest for their holdings in its treasury. This interest is referred to as the reverse repo rate.

No, the repo rate is fixed for all banks. This is because it is decided as per the Monetary Policy issued by Reserve Bank of India.

Introduced in July 2010, the Base rate was a standard lending concept coined by the Reserve Bank of India. The base rate is the minimum interest rate below which banks are not permitted to issue loans to their customers.

MCLR stands for the Marginal Cost of Funds based Lending Rate.

MCLR defines the minimum standard rate below which banks are not allowed to lend loans linked to the MCLR regime.

From April 2016 onwards, the Reserve Bank of India (RBI) has proposed a new method for setting the lending rate. As per RBI’s new mandate, the Marginal Cost of Funds based Lending Rate (MCLR) regime has replaced the previous base rate system with an aim to enhance transparency and flexibility in the way banks and NBFCs publish rates.

The external benchmark rate refers to the reference rate. As per RBI’s mandate, all floating rate loans including personal and retail loans(housing, vehicle, etc) sanctioned after October 01, 2019, shall be linked with any one of the following external benchmarks:

  • RBI’s Policy Repo Rate
  • The Government of India’s yield on three-month or 6-month Treasury Bill published by the Financial Benchmarks India Private Ltd. (FBIL)
  • Any other benchmark interest rate published by FBIL.

For banks, the repo rate is published on a monthly basis. Whereas for customers it remains the same until their next quarterly interest-rate reset date.

Repo rate is published by banks every month on a pre-announced date. The rate applicable to a borrower would be the prevailing repo rate for that specific month.  Moreover, this rate has a reset period of three months; hence it will change every three months.

Banks can issue interest-rate reset date for loans which will be linked either to the date of loan disbursement or the date of MCLR/Repo rate review. For an instance, if the reset duration is three months, the Home loans/Loan against Property issued in April 2020, will have reset date in July 2020 and so forth regardless of changes in benchmark during the said interval. Loans are reset according to the pertinent month’s MCLR rate as applicable on a particular date.

The Repo rate is revised once every three months. The increase or decrease in the Repo rate first influences the loan tenure and if the maximum tenure extension has been availed then loan EMI will be changed.

For deciding the applicable Repo rate, loan disbursement month is considered rather than the month of loan sanction.

Exactly, there is no way through which a customer can move back from REPO RATE to MCLR/ BR/BPLR.

Yes, a borrower can continue with MCLR/ BR/BPLR system as long as he/she desires. Conversion to the Repo rate will only be considered on the borrower’s request or in case of a balance transfer.

Borrowers can switch over to External Benchmark at mutually agreeable terms with the bank. To shift to Repo Rate borrower can request the bank by paying some administrative/legal fee. Although there are no charges for the conversion of loan to Repo Rate.
Post conversion, the rate charged to borrowers on loan is the same as a new loan of the same type, tenor, and amount, at the time of loan origination.

Since banks review Base rate/MCLR from time to time, there is a possibility it may or may not change.

To switch from the existing benchmark rate of MCLR/BR/BPLR to Repo Rate, the customer is required to visit the concerned bank branch and sign an agreement in support of the conversion of loan to Repo Rate based benchmark.

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