To spread the New Year’s cheer, State Bank of India (SBI) has reduced its external benchmark rate by 25 basis points, making it 7.80% from 8.05%. This new rate change will be effective from January 1, 2020, and will be a treat for home loan buyers, further reducing their EMI burden. 

“The external benchmarks are RBI’s Repo Rate, Treasury Bill Yield (91-day T-bill Yield) and (182-day T-bill Yield) of Government of India and any Other Benchmark Market Interest Rate.”

According to SBI’s press release”With this reduction, the interest rate for existing home loan customers as well as MSME (micro, small and medium enterprises) borrowers who have availed loans linked to external benchmark based rate would come down by 25 bps.”

With this new rate cut coming into effect, the new home loan buyers would be able to avail a loan at an interest rate starting from 7.90% per annum as compared to an earlier interest rate of 8.15% per annum. 

Currently, SBI’s external benchmark lending rate is 5.15% plus 265 basis points, which is linked to RBI’s Repo Rate. Till now, RBI has reduced its repo rate by 135 bps, while banks have only provided the benefit of 44bps with regards to new loans. 

Being country’s largest lender, SBI came first in the league to cut the external benchmark rates, after the Reserve Bank of India (RBI) maintained the status quo in its December’s Monetary Policy, making home loans affordable. 

Though RBI has instructed all banks to adopt the new external benchmark based rate structure so that the benefits of its Monetary Policy will easily be passed on to the customers. 

So, unwrap your New Year’s gift of pocket-friendly home loan EMIs offered by SBI.

A Sneak Peek on Benchmark Lending System

Background

When it comes to loans, earlier banks used to lend money linked to the Marginal Cost of Funds based Lending Rate(MCLR), also known as internal benchmarking. Every bank has its own internal benchmark rate, which depends on various factors like-fixed deposit rates, source of funds and savings rate. When a customer asks for a loan, here the power lies in a bank’s hand to give away the loan on an MCLR, including the spread (bank’s own profit). 

The Problem with MCLR-based Lending System

In the case of the MCLR system, the biggest hurdle was the lack of transparency and transmission of policy rates. When RBI changes its repo rate, there is no guarantee that a borrower would be able to reap its benefits. That’s Right! MCLR, being an internal benchmarking system, here, the bank will decide the loan price, rate cuts, which often don’t reach out to the borrowers. Depending upon a bank’s individual profit and performance in terms of business, it used to have an authority to lend loans based on its own terms. 

How the New External Benchmark System Will Work

Under the new benchmarking system, which came into effect from October 1, 2019, any personal, housing or auto loan taken from a bank will be linked to an external benchmark instead of MCLR as per Reserve Bank of India. A statement issued by RBI also stated that the banks can set the interest rate of the loans to any of the following external benchmarks:

1. RBI’s Repo Rate
2. Government of India three-months Treasury Bill Yield (91-day T-bill Yield)
3. Government of India Six-months Treasury Bill Yield (182-day T-bill Yield)
4. Any Other Benchmark Market Interest Rate

What Does External Benchmark Mean for You?-The Benefits It Has

With a major change in the way banks used to lend, it would be interesting to see how the linking of interest rates to any of these external benchmarks on different categories of loans would be beneficial for the customers. 

With these benchmarks, banks are also allowed to decide their spread value, which will be fixed for the tenure of the loan. However, a bank can change it, based on the eligibility (credit score of a borrower). 

It is expected that this external benchmarking system will bring a big smile on the faces of loan borrowers, allowing them to enjoy lower interest rates, leading to pocket-friendly EMIs.