Borrowers struggle in deep sea as banks deflate life jackets

After having been chided by Finance Ministry officials and then having been reminded by Prime Minister Narendra Modi – in his December 31 address to the nation – about the gains that had accrued to them following the withdrawal of high-value banknotes, banks ended up sharply reducing lending rates in early January.

Following demonetisation, high-value currency notes that had been withdrawn were deposited in banks by account holders, mostly in current and savings accounts. Since most banks offer only a 4 per cent interest rate on savings accounts (no interest is paid on current account deposits), banks’ overall cost of funds came down sharply. So, banks were asked to pass on the benefit of lower costs to the borrowers.

State Bank of India (SBI) reduced its marginal cost of funds-based lending rate (MCLR) by 90 basis points, ICICI Bank by 70 bps, HDFC Bank by up to 90 bps. (100 bps = 1 percentage point.) These rate cuts would lower interest costs for new borrowers. However, existing borrowers may find little to cheer about.

MCLR vs Base rate

MCLR is the benchmark lending rate to which all loan rates are linked. MCLR came into effect from April 1, 2016, replacing the erstwhile benchmark base rate. The Reserve Bank of India (RBI) had decided to shift to the MCLR regime to improve monetary transmission, since banks were reluctant to cut interest rates despite the central bank reducing the key policy rate, i.e. the repo rate.

However, if a customer had taken a home loan before April 1, 2016, for example, (on base rate) and if he or she had not shifted to the new loan pricing mechanism – MCLR – (which one can do by paying a fee), then his or her interest burden would not have declined significantly as a result of the January rate cut.

About 80 per cent of the loans that were taken before April 1 continue to be base-rate linked.

Sample this: While SBI has reduced its MCLR by 90 bps in January, it reduced its base rate by only 5 bps. The same is the case with its peers – ICICI Bank, HDFC Bank, Axis Bank – to name a few.

So, a new borrower could get a home loan at 8.6% from SBI (for loans up to ₹75 lakh) but existing borrowers will have to continue to pay above 9%.

But why are banks reluctant to lower the interest rate for existing customers?

“Our discussion with banks seems to suggest that about 15-20 per cent loans are linked to MCLR while the rest is linked to the base rate or other rates,” said Karthik Srinivasan, Group Head - Financial Sector ratings, ICRA.

“So, this sharp cut will impact some of the borrowers. If banks have cut the base rate there would have been a sharper hit on the margin. The other reason is, banks have cut MCLR sharply to push credit growth so that new borrowers come into the borrowing system,” Srinivasan said.

Deciding on the pricing of loans and protecting margins are business decisions; but not lowering a floating rate for loans while interest rates are coming down is akin to not honouring the contract that a bank and the customer sign while a loan is sanctioned.

‘Systemic failure’

K.C. Chakrabarty, former Deputy Governor, RBI, said such a practice reflects as a failure of the entire system.

“It is total failure of the judiciary, consumer court, regulator... everyone,” Mr. Chakrabarty told The Hindu . “Floating rate cannot be different for different customers with the same risk profile. If LIBOR comes down then can I say that my costs have not come down?” he said.

Asked what the regulator should do if banks are reluctant to cut rates? “The regulator should say if I cut the rate by 50 bps, then all your (banks’) rates - deposit, lending... should come down by 50 bps. That should be the directive,” he said.

Chakrabarty also questioned the timing of the rate cut. “If banks are saying if it is because of demonetisation that the cost of funds has come down, then MCLR cuts should have happened in the beginning of December.”

The withdrawal of high-value notes came into effect from November 9 and banks started to accept deposits from November 10. A substantial amount was deposited in November itself. According to RBI norms, banks are supposed to review the MCLR once a month. Most big banks announced rate cuts much later than early December.

“Some banks announced rate cuts on January 1, which was a Sunday - a day after the Prime Minister’s address. I don’t know which banks work on Sundays,” Chakrabarty said suggesting that banks decided to cut interest rates after being nudged by the government.

Existing borrowers’ options

So, what should existing borrowers – who are still on the base rate – do to get the benefit of MCLR cut? Banks offer to switch loans from the base rate to the MCLR but that comes with a fee. The fee and its structure differ from one bank to another. Some banks charge a percentage of the loan outstanding, while others charge a flat fee. Bankers said that since the MCLR cut is sharp, the borrower stands to gain on a switchover.

“I think the processing charges are quite minimal,” said Arundhati Bhattacharya, Chairman, SBI at a recent interaction with the media. “There is a lot of work there. You have to redo the entire documentation. Given that we are bringing down rates so much substantially, a customer will recoup the processing fee amount in just 5 or 6 months,” she said.

Before deciding to switch from the base rate to the MCLR, a customer should make relevant calculations to see if such an exercise is financially beneficial.

(This article first appeared in The Hindu dated February 6, 2017)

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