The rate cuts for new mortgage loans will be automatically transferred

MUMBAI: All banks are now required to link extended-rate loans extended to retailers and small businesses with repo rate - the rate at which lenders borrow from RBI - or for treasury fees as of October 2019. The move occurs days later public sector banks announced a large number of loans linked to the repository after a push from the finance minister Nirmala Sitharaman .

In a circular to all banks, RBI said floating rate loans for housing, auto and other personal advances as well as those advanced to micro and small enterprises have to be linked to one of three external benchmarks instead of the Marginal Cost of Lending Rate (MCLR). These three include RBI 's repo rate , three-month or six-month treasury bill yields, or any benchmark rate provided by Financial Benchmarks India (FBIL), a money market service provider which publish debt market rates.

SBI was the first to offer repo links mortgage loans and deposits and other PSBs have followed suit. These lenders include IDBI Bank, Bank of India, Union Bank of India, Central Bank of India, United Bank of India and Allahabad Bank, among others. Many lenders are also offering savings deposits linked to the repository.

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RBI has said that existing loans and credit limits linked to the MCLR/Base Rate/prime lending rate shall continue till repayment or renewal, as the case may be. Those customers wanting to switch to the repo-linked rate can do so on 'mutually acceptable terms', RBI said.

The argument against the current benchmark - the MCLR - was that it did not effectively transfer rate reduction announced by RBI to borrowers. RBI, while announcing a 35 basis points (100bps = 1%) cut in repo in its August policy had pointed out that although it had brought down rates by 75 basis points the weighted average MCLR of banks had come down by only 29 basis points.

Banks had argued that the MCLR formula is calculated based on cost of funds and these come down only gradually after a repo rate cut.

The efficacy of the repo as a benchmark rate was demonstrated in SBI's repo-rate linked home loan which is priced at 8.05%, sharply lower than the MCLR-linked home loan. With the economy in the throes of a slowdown there is a strong likelihood that RBI will cut rates further to spur demand.

The external benchmark was first proposed by the former governor Urjit Patel in 2018. Banks had opposed the external benchmark claiming that their cost of funds did not move in line with the markets, after which the directive, which would take effect in April 2019, was suspended.

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