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HomeBusinessExplained: Why your home and auto loan rates are set to go...

Explained: Why your home and auto loan rates are set to go up despite RBI keeping repo rate unchanged

Your home and auto loans rates are set to rise as several banks, led by India’s largest public sector Bank State Bank of India have raised their marginal cost of fund-based lending rates (MCLR) in the last three days.
MCLR, which came into effect from April 1, 2016, is the minimum rate below which banks are not permitted to lend.
This week SBI, Bank of Baroda, Kotak Mahindra Bank and Axis Bank raised rates. This is the first time that such a raise has occurred since 2019, implying that the soft rates regime that has prevailed for the last three years is coming to and end as India battles inflation.
“Since the onset of the Covid, on the median basis, the banks have cut their 1-year MCLR by 110 bps as compared to 130 bps cut in their 1-year deposit rates. As we expect the credit growth to further improve and liquidity surpluses to reduce in the ongoing year, we expect the banks to hike their deposit rates, which will result in an increase in their MCLRs also,” said Anil Gupta, Vice President & Co-Group Head, ICRA.
Interest rates have been low for the last few years. Now public sector and private sector banks have started increasing lending rates, initiated by SBI. This results in costlier consumer loans like car, home and personal loans.
SBI raised its MCLR by 10 basis points or 0.1 percentage point across all tenures, while the other three have raised it by 5 bps, or 0.05 percent across the board. Effective April 15, SBI’s MCLR of one-year stands at 7.1%, two-year at 7.3% and three-year at 7.4%. Axis Bank’s one-year MCLR effective April 18 is at 7.4%, two and three years at 7.5% and 7.55%, respectively.
“From the beginning of 2022, banks have started increasing deposits rate. This leads to a wider gap between lending rate and deposit rates. Inflationary pressure is also rising and this will force RBI to increase repo rate soon. This move will further increase lending rates,” said Sucheta Mahapatra, managing director of Personal finance app Branch.
The history: The Reserve Bank of India (RBI) had issued guidelines on computing interest rates on advances based on the Marginal Cost of Funds based Lending Rate (MCLR) to banks vide circular dated December 17, 2015. It came into effect on April 1, 2016. It was introduced to help the banks become more competitive and improve transparency in loan pricing.
What is MCLR

“MCLR is an interest rate benchmark. A benchmark rate is the lowest rate at which a bank can lend. Lenders apply their mark-up over this benchmark to create a retail rate of lending. For example, let’s say a bank has a one-year MCLR of 7.10 over which it applies a mark-up of 35 basis points, which gives us a retail rate of 7.45.
MCLR is an internally produced benchmark by banks. It is set for various tenors ranging between overnight and three years. Banks link their deposit and loan rates to various MCLR tenors. For example, a government bank benchmarks its home and auto loan rates to its one-year MCLR,” explains Adil Shetty, CEO of BankBazaar.
How is MCLR calculated?
MCLR is calculated on the basis of Cash Reserve Ratio, marginal cost of funds, tenor premiums and operational cost of the bank. If the cost of funds goes up, the MCLR increases, and the loans linked to any MCLR tenor get more expensive. Similarly, if the MCLR comes down, your loans get cheaper.
How does it work?
Bank loans issued between April 1, 2016, and October 2019 are all linked to MCLR. Home loans issued after that date are linked to externally produced benchmarks such as the repo rate. Borrowers have the option of refinancing their MCLR-linked loans to repo-linked loans which are known to be more transparently priced and better transmitters of policy rate cuts, added Shetty.
What does the latest hike in MCLR imply?
The latest spikes in MCLRs at various banks indicate that deposit and loan rates are poised to rise. For MCLR-linked loan takers, the rate reset might happen as indicated in their loan agreement. Typically MCLR-linked home loans have rate resets once every six or twelve months.
Point to note: Under the MCLR regime, banks are mandated to adjust their interest rates as soon as the repo rate changes. Most economists are expecting the RBI to hike the repo rate by 25 basis points from 4 percent now, as early as the June policy. Banks are already assuming that such a hike will occur, which is why several have hiked their MCLRs. But this hike will be applicable only on floating rate loans and not on fixed interest rate loans.
What happens when rates rise?
Typically in a rising rate environment, lenders keep the EMI same and increase the loan tenure to account for higher interest burden. However, certain long-tenor loans, such as home loans, where increase in tenor may not be possible, the lenders will have to increase the EMIs also, which will increase the debt servicing burden for the borrowers. “This could mean lower disposable incomes leading to adverse impact on consumption and demand. Higher EMIs could also result in increase in delinquencies for lenders,” said Icra’s Gupta.
What should a borrower do?
Borrowers need to assess their situation to understand if it makes sense for them to remain with an MCLR-linked loan with the possibility that their reset may still be months away which allows them to enjoy lower rates a little longer. “If not, they can refinance to lower rates, increase their EMIs, or pre-pay their loans to soften the interest spike,” said Shetty.
Why has the MCLR been hiked?
The increase in the MCLR by various banks has come after the Reserve Bank of India sounded hawkish as it turned its focus on tackling inflation In the monetary policy review meeting held earlier in April. The increase in the MCLR rates comes after deposit rate hikes by banks in the past few months.
One of the main reasons for MCLR increase is a rise in the bulk deposit rate by banks, according to Madan Sabnavis, chief economist at Bank of Baroda. “Since new retail and home rates are now marked to external benchmarks like the repo or the 10-year G-sec, corporates largely will see their borrowing rates rise.”
The proportion of loans linked to MCLR had the highest share of 53% as of December 2021, even as proportion of floating rate loans linked to external benchmarks like repo increased to 39% in December from 29% at the end of FY 21.
“In accordance with the RBI report on Monetary Transmission in India, the share of loans linked to the MCLR stood at 62.9 per cent as of March 2021. So, a hike in interest would mean a heavier repayment burden for a substantial section of the borrowers,” said Adhil Shetty, chief executive officer, BankBazaar.com.




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