The Reserve Bank of India (RBI) had introduced Marginal Cost of funds based Lending Rate (MCLR) on April 1, 2016, to make up for the limitations of Base Rate, which was the lending rate benchmark at that time for all retail loans extended by commercial banks. However, the delay by banks in passing on the benefits of a repo rate cut to customers under the MCLR regime led RBI to come up with an alternative plan – the introduction of External Benchmark Lending Rate. Following the RBI’s guidelines, from October 1, 2019, all banks have linked retail loans to either RBI’s policy repo rate or any other benchmark market interest rate published by the Financial Benchmarks India Private Limited (FBIL).
The fact that there has been a major change in the way banks price loans makes it important for you to understand every aspect of it. In this post, learn how the current external lending rate benchmark (Repo Linked Lending Rate (RLLR)) is different from the earlier internal lending rate regime (MCLR).
Home loan interest rates constitute of two main components:
- Reference rate – A reference rate is a benchmark below which lenders cannot lend money to their customers. It can be either internal or external. The Internal Benchmark Lending Rate, which earlier was Marginal Cost of funds based Lending Rate (MCLR), is set by lenders under guidelines set by the RBI. External Benchmark Lending Rate, on the other hand, could be linked to RBI’s repo rate or any other benchmark market interest rate published by FBIL.
- Spread/margin – Home loan rates also include spread, which is the bank’s profit margin added over and above the reference rate. It is set on the basis of customer- and product-specific factors such as the applicant’s credit score, loan amount, etc.
Read Also: Home Loan Interest Rates Comparison
What is Repo Rate?
The rate at which the banks borrow funds from the RBI is known as the repo rate. A cut in the repo rate makes it cheaper for banks to borrow money from RBI. This allows them to lend money to borrowers at a lower rate.
Must Read: All You Need to Know About Repo Rate
What is MCLR?
MCLR is a tenor-linked internal benchmark that determines the interest rate of retail loans like the home loan. It is the minimum rate at which a financial institution can extend loans to its customers. The rate was introduced to increase the average revenue generated by financial institutions through the extension of loans as per their marginal cost of funds. This is in direct contrast to the base rate, which considered the aggregate cost of borrowings of lending institutions. MCLR is calculated internally by the bank on the basis of four components – Marginal Cost of Funds, Cash Reserve Ratio (CRR), Tenure Premium and Operating Costs.
Suggested Read: Learn more about MCLR and its 4 components
Based on the above components, a 1-year MCLR formula for a bank = Interest rate offered by the bank on 1-year term deposit + CRR + Tenure Premium + Operating Costs.
Thus, banks set MCLR for different tenors – overnight, 1 month, 3 months and 6 months. But the final MCLR-linked loan interest rate is decided by the bank after adding spread to the MCLR on the basis of your credit profile, loan amount, tenure, etc.
What is RLLR?
RLLR is an external benchmark, wherein, the RBI’s repo rate is used by commercial banks to calculate the retail loan interest rate. In case the repo rate of 5.75% is reduced by 35 basis points to settle at 5.40%, the RLLR of all banks having repo rate as the external benchmark will reduce by 35 basis points. RLLR of all banks comprises the prevailing repo rate, tenure premium and pre-set spread or margin maintained for adequate revenue generation.
RLLR Vs. MCLR
In the following sections, the key differences between MCLR and RLLR are elaborated to help you understand the new RLLR regime better.
MCLR and RLLR in a Nutshell
|1.||Benchmark Link||Internal mechanism of bank||External (RBI Repo Rate)|
|2.||Reset Period||6 or 12 months, depending on the bank||3 months|
|3.||Transmission Rate||Relatively slower||Faster transmission|
Let us understand how MCLR is different from RLLR.
- Benchmark Linking: MCLR and RLLR follow different benchmark systems. MCLR is an internal benchmark of the bank, which implies that it is set by the lending institutions after taking into account their own cost of funds. Here, the repo rate is not the sole factor determining the lending rate. Factors like g-sec rates, low-cost deposits, banking system liquidity, etc. affect the cost of funds for banks. Hence, a reduction in the repo rate does not translate to a similar fall in the MCLR of banks.
RLLR, on the other hand, is an external benchmark that is linked to the repo rate. The bank’s own cost of funds is not impacted by any change in the repo rate. Hence, whenever RBI revises the repo rate, the bank’s RLLR gets changed, thus, affecting the RLLR-linked home loan interest rate. Every bank has its own RLLR. Moreover, the external benchmark ensures standardisation and provides greater transparency, as borrowers do not rely on banks to inform them about rate changes. They can track the benchmark themselves.
- Reset Period: In case of MCLR linked home loans, the rest period is usually 6 months or 12 months. This means that banks would revise their MCLR every 6 or 12 months. A change in MCLR would accordingly change the home loan interest rates and subsequently the loan EMIs. Such a long reset period gives a time-lag to MCLR-linked loans.
In case of RLLR, the reset period is of 3 months. This implies that your interest rate of RLLR-linked loans would help to revise the EMIs every 3 months. This way, the borrowers would be able to enjoy the benefit of the repo rate cut. However, in case of a rise in the repo rate, the loan rates will also increase quickly.
- Volatility: The volatility or the frequency at which floating loan rates change can be determined by whether they are linked to RLLR or MCLR. As per RBI guidelines, the interest rates linked to RLLR are subject to revisions every 3 months. In other words, any change in the repo rate will reflect in a change in the RLLR of commercial banks every 3 months. The MCLR-linked loan rates, on the other hand, are revised once every 6 or 12 months. Hence, the volatility of the loan rates linked to RLLR is more compared to the volatility under the MCLR regime.
How much do you expect to save on RLLR-linked loans?
To understand how much you can save on RLLR-linked loans compared to MCLR-based loans, let’s take an example of Punjab National Bank (PNB) home loan.
Home loan: Rs. 50 lakh
Loan tenure: 20 years
PNB 1-yr MCLR: 8.15%; RLLR: 7.80%.
Let us look at the difference in EMIs and the total interest pay-out.
|Particulars||Interest rate (MCLR-linked||Interest rate (RLLR-linked)|
|Monthly Loan Instalment||Rs. 42,290||Rs. 41,202|
|Total Interest Amount||Rs. 51,49,593||Rs. 48,88,433|
|Interest Amt. Saved under RLLR Regime||Rs. 2,61,160|
As per the above example, the total interest burden is lower in case of RLLR-linked home loans than in MCLR-based home loans. The monthly instalment is also relatively lower in case of RLLR-linked home loans. Thus, the amount saved can be used for investment in mutual funds or fixed deposit, or for meeting other financial requirements.
Word of Advice
It is expected that in case of repo rate-linked home loan, there would be a faster transmission of rate changes, greater transparency and improvement in the liquidity situation in the Indian economy. However, before making a switch from MCLR to RLLR or from one bank to another with different RLLRs, keep certain points in mind:
- Compare current home loan rates with the new ones. The home loan rates under RLLR regime should be lower than the current MCLR-based home loan interest rates.
- If the principal outstanding is huge, shifting from MCLR to RLLR would make sense even if the difference between the old and new interest rates is just 20-25 basis points.
- Under the RLLR regime, compare rates and other factors like margin and spread before switching from one bank to another. If the margin is higher for a bank in spite of its lower RLLR, the total savings would decrease and in such a situation, it is advisable not to switch to this bank