Interest on housing loans: Should you take out loans that are linked to benchmarks other than the repo rate? Which banks offer these?


img
The Reserve Bank of India (RBI) had mandated banks to tie interest rates to: loans to external benchmarks. This came into effect on October 1, 2019. Other than the RBI‘s repo rate, banks are allowed to link the interest rates they charge on loans to other external benchmarks such as Treasury Bill Yield (T-bill), Mumbai Interbank Outright Rate (MIBOR) etc.

According to the central bank’s monetary policy report for April 2020: “After the introduction of the external benchmark system in the banking sector on October 1, 2019, 36 banks – of the 62 banks from which information was collected – adopted the policy repo rate as the external benchmark for floating rate loans to the retail and micro and small enterprises (MSE) sectors. Six banks have linked their loans to various other benchmarks published by Financial Benchmarks India Private Ltd (FBIL), such as the CD rate, the overnight index swap (OIS) rate, the Mumbai Interbank Outright Rate (MIBOR) and the 3 -month T-Bill interest. Eleven banks have linked different sectors to different benchmarks.”


RBI LoansET Online

According to RBI, banks can choose any of these external benchmarks:

(i) RBI’s repo rate

(ii) Quarterly Government of India Treasury Bill Yield published by the Financial Benchmarks India Private Ltd. (FBIL)

(iii) The Proceeds of Six Months of Treasury Bills of the Government of India published by the FBIL

(iv) All others by the FBIL. published benchmark market interest rates

Banks that have not linked their loan interest to the repo rate

According to the RBI, six banks have linked the interest rates on their loans to different benchmarks published by the Financial Benchmarks India Private Ltd (FBIL) and eleven banks have linked different sectors to different benchmarks.

So, what are the benchmarks these banks have chosen? Here’s a look at the external benchmarks chosen by five banks.

Banks External benchmarks
(other than repo rate)
Mortgage interest rate (%)
German Bank MIBOR & T Bill Not available
Citibank T-note 7.34-8.29
Suryodyay Small Finance Bank T-invoice Not available
Standard chartered bank MIBOR from 9.16
Yes Bank 6 months CD rate 10.12-13.27

Source: Paisabazaar.com; As of April 20, 2020

Does it really matter to a borrower which external benchmark the interest rate of his loan is linked to? Read on to find out.

How does interest linked to an external benchmark work differently from repo interest?

According to experts, the interest rate linked to other benchmark rates, such as the certificate of deposit (CD), T-Bill rates and other benchmarks published by the FBIL, works in the same way as loans linked to the repo rate. These benchmarks act as a reference rate for banks to determine their borrowing rates after adding their spread (margin) and credit risk premium based on the borrower’s credit profile.

However, there is one thing to keep in mind: these are market-based rates. Naveen Kukreja, CEO & Co-Founder of Paisabazar.com explains: “Because they are based on market-based benchmarks, these benchmark rates can vary on all trading days. Therefore, banks use the benchmark rates published by FBIL on predetermined dates as their reference rates for determining the interest rates of new loans and resetting the interest rates for their existing borrowers.”

For example, Citibank reviews and publishes monthly the TBLR it uses. The T-Bill Reference Rate (TBLR), published by FBIL on a predetermined date, 12th of each month, is used as the basis for TBLR by Citibank. If the 12th of a month is a public holiday, the rate of the next working day will be applied. In the case of Standard Chartered Bank, the interest rates for loans are linked to the MIBOR. The bank offers 1-month MIBOR and 3-month MIBOR as external benchmarks. The MIBOR rate applied by the bank is based on the MIBOR as on the 11th of each month.

Repo rate versus other external benchmarks

Since banks are free to choose the external benchmark for linking loan interest rates, many banks have chosen the repo rate as the benchmark as it is easier for the borrower to understand and can be less volatile compared to the others. market-based external benchmarks .

Shalini Gupta, Chief Strategy Officer, MyLoancare said: “Repo rates are policy rates announced by RBI in its bimonthly monetary policy for the purpose of managing liquidity, inflation and other macroeconomic parameters. Other benchmarks, such as T-invoice – and OIS rates are market driven and can fluctuate in response to continuous changes in supply-demand, domestic and global economies, as well as RBI policy rates.The repo rate is easier to understand for a regular customer.Other external benchmark rates such as T-Bill rates etc. are volatile and can lead to more fluctuations in a customer’s EMI.”

While market-based interest rates may be more volatile, the repo rate and other significant changes in monetary policy also affect other external reference interest rates and vice versa.

“Other external benchmarks can be more volatile than the repo rate revised by the RBI, usually every two months. However, the repo rate and other significant changes in monetary policy also affect other external benchmark rates and vice versa. This reduces the possibility of a big difference between the movement of the repo rate and other external benchmark rates.Other external benchmark rates will usually follow the broader interest rate movement in the economy,” said Kukreja.

Which loans are cheaper: repo-linked interest loans or other benchmark-linked loans?

In addition to the external benchmark, the bank’s margin and the customer’s credit risk profile also play an important role in determining the effective interest rate on the loan.

For the home loan product of the State Bank of India, SBI Term loan, the interest rate ranges from 7.2 to 7.55 percent and for ICICI Bank around 8.10-9.10 percent. Both banks have linked their lending rates to the repo rate. In comparison: Citibank’s interest on home loan ranges from 7.34 percent to -8.29 percent and for Yes Bank (according to Paisabazaar.com data) it is about 10.12-13.27 percent.

Repo rate versus non-repo rate linked interest on home loan

Banks External benchmark Interest on home loan (%)
German Bank MIBOR & T Bill AFTER
Citibank T-note 7.34-8.29
Suryodyay Small Finance Bank T-note AFTER
Standard chartered bank MIBOR from 9.16
Yes Bank 6 months CD rate 10.12-13.27
SBI Term Loan Repo rate 7.20 – 7.55
ICICI bank Repo rate 8.10 – 9.10
Kotak Mahindra Bank Repo rate 8.20 – 9.15
Punjab National Bank Repo rate 7.20 – 7.75
Bank of Baroda Repo rate 8.25 – 8.50

Source: Paisabazaar.com and the bank’s websites; data as on April 20 & 21, 2020

What should a borrower do?

“Factors such as past trends in repo rate movement and other external benchmark rates are important to assess the potential advantage of one benchmark over another. The client should choose a benchmark with a level of volatility that is within the client’s risk appetite Since most banks are on a repo interest rate benchmark, customers can also compare lending rates from one bank to another and make an informed decision,” Gupta says.

It’s not just the interest rates that should be the main focus of the borrower, there are other factors to consider as well.

Kukreja says, “Borrowers should avoid considering the type of external benchmarks used by the lenders when making their loan selection. Instead, borrowers should focus more on other factors such as processing fees, loan term, loan amount , loan-to-value ratio, etc. while choosing between the lenders. If borrowers find cheaper loan rates over time, they can always transfer their loans to lenders that offer lower rates.”

This div height required for enabling the sticky sidebar