The Reserve Bank of India's (RBI) decision to link base rate for loans with the marginal cost of funds-based lending rate (MCLR) from April 1 is likely to hurt borrowers seeking home loans.
While the central bank's intentions are good as it wants to ensure that customers benefit from the interest rate movements set by the regulator, its the timing that's not in its favor.
The move comes at a time when the interest rates are poised to rise after nearly four years easing cycle, according to market experts.
Base rate is the benchmark that banks use to charge consumers who took home loans before April 2016, and MCLR is the latest benchmark based on cost of funds. Base rate is determined by the average cost of funds, in contrast to the MCLR that depends on the current cost of fund.
Last year, most banks had sharply reduced MCLR as they were flush with funds but the base rate remained unchanged meaning retail borrowers were still paying higher interest rates.
The central bank expressed concern over weak rate transmission as a large portion of bank loans remain linked to the base rate despite the introduction of the MCLR in April 2016. The MCLR is more sensitive to monetary policy transmission and is closely linked to the actual deposit rates.
"We are concerned about the inadequacy of monetary transmission to base rate," N S Vishwanathan, deputy governor of the RBI said last month.
"Harmonising the calculation of base rate with MCLR so that responsiveness of the credit portfolio to monetary policy signal is not hindered by large part of bank's portfolio linked to base rate."
For instance, since April 2016, while the repo rate has been reduced by 75 basis points, State Bank of India's base rate has come down by 65 basis points but the one-year MCLR by as much as 1.25 percentage points. One basis point is one-hundredth of a percentage point.
But with interest rates already rising more than 20 basis points from their trough, the linking of base rate to MCLR would raise the monthly payments for borrowers.