Top 5 Things to know about RBI New Loan Rate

MCLR Calculations

As per the RBI guidelines, marginal costs are charged based on these factors:

1. Borrowings meaning the repo rate, long-term interest rate, and short-term interest rate
2. The interest rate offered on deposits including savings deposits, current deposits, term deposits, and foreign currency deposits.
3. Return on net worth

The Marginal Cost of Funds will be based on these components:

1. 92% of the MCLR is determined by the marginal cost of funds, deposit rate and repo rate. The return on net worth will comprise of 8%.
2. The MLCR is calculated on the basis of the interest rate offered by a bank on deposits and the repo rate.
3. From the MLCR calculations, the base rate will be derived.
4. The MCLR will be revised on a monthly basis taking into consideration the repo rate and other rates related to borrowing.
5. Based on the MCLR, the bank will have to fix interest rates for different types of customers according to their risk factor.
6. The new guidelines direct all the commercial banks to prepare the new internal benchmark lending rates based on the marginal cost of funds.
7. Five benchmark rates are required for different tenures which range from 1 day to 1 year.
8. The banks have the freedom to set rates for tenures exceeding 1 year.
9. Banks cannot lend below the MCLR but there are a few exceptions.
10. Banks can lend below the MCLR under these circumstances:
    1. Loans against deposits
    2. Loans to employees of the respective bank

Loans linked to MCLR

The important question that arises now is - How will MCLR affect my loan? If your existing loan is based on a fixed rate of interest, then the MCLR will not be applicable to you. The MCLR will be applicable to all floating rate loans that are sanctioned from 1 April 2016. In cases of credit renewal, the MCLR will come into effect. Existing borrowers can switch over to the MCLR system if they wish. MCLR-linked loans can include:

1. Home loans
2. Auto loans
3. Loan against Property
4. Educational loans
5. Corporate term loan

If you borrowed your loan from a Non-Banking Financial company, the MCLR is not applicable. MCLR applies only to banks.

What does MCLR mean for existing loan borrowers?

For borrowers who already have a loan sanctioned, they have the option to continue under the base rate system or switch to MCLR. If the borrower chooses to switch over to the MCLR scheme, they cannot go back to the base rate system. To change your loan to the MCLR system, you need to follow these steps:

1. Request your bank to link your loan to the MCLR.
2. Request the bank to reduce your quantum of spread.
3. For the conversion, there may be a one-time fee applicable which you must pay.

Another important question arises here and that is whether it is advisable to make the switch or stick to the old system? At present, the MCLR-linked loans are cheaper making the option of conversion appealing. But in the future, there is a possibility of the RBI increasing the rates. This will lead to a higher rate of interest on your loan. So, to find out if the shift is worth it, you need to take into account the fees payable, the tenure remaining and if the new interest rate is beneficial. 

You can use an EMI calculator to find out the difference in your monthly payments. If converting to the MCLR regime means you benefit by 25 basis points or more, and you have a long tenure left, then the shift might be a wise. If shifting means only a difference of 10 basis points or less, and you have a short-term left on your loan, it would be better to stay with the basis point regime. 

Effects of MCLR

1. Transparency - The new loan rate brings in a sense of transparency. Customers are more aware of the change in interest rates and the reasons for them.
2. Interest Rate - With the base rate system, the RBI noted that banks were extremely slow in cutting their rates when the RBI slashed the repo rate. But on the other side, when the RBI increased rates, the banks promptly increased their rates as well. The MCLR scheme aims at changing this situation and regulate the interest rates of banks more often according to the cost conditions.
3. Reset Clause - Reports suggested that banks would initially offer loans with low-interest rates and low spreads. But within a few months into the loan, the banks increased the spread for no justified reason. This was an unfair practice that affected the customer’s loan negatively.

      With the MCLR system, banks must set a spread on the loan when it is sanctioned. The banks can increase the spread only within the range set. The spread can be changed only in case the          profile of the borrower changes.

1. Spread - Reports suggested that banks would initially offer loans with low-interest rates and low spreads. But within a few months into the loan, the banks increased the spread for no justified reason. This was an unfair practice that affected the customer’s loan negatively. With the MCLR system, banks must set a spread on the loan when it is sanctioned. The banks can increase the spread only within the range set. The spread can be changed only in case the profile of the borrower changes.
2. Regulations on banks - Banks are now restricted on the spread they can charge during the loan tenure. Banks are also required to publish fresh interest rates on a monthly basis for at least 5 tenures.

Exemptions under MCLR

1. MCLR does not apply to fixed - rate loans. If you have taken a car loan, home loan, personal loan or any other loan with a fixed rate of interest, then the MCLR does not apply to you.
2. Only banks will follow the MCLR regime. Any loans taken from finance companies and non-banking financial companies will not fall under this system. This includes NBFCs such as India bulls, LIC Housing Finance, Dewan Housing (DHFL), HDFC, et cetera.
3. Loans that fall under government schemes are exempt from the MCLR as the rate of interest will be set by the government.

The MCLR is aimed at bringing in a better system that ensures fair practices and better loan terms for the end customer. The Reserve Bank of India is taking steps to change the way the banking world functions and introduce a working model that will allow the RBI to exercise more control over banks and in turn direct the Indian economy in a better direction.