RBI last year introduced external benchmark linked retail loans with an objective to hasten the transmission of declining interest rate to retail and MSME borrowers in a transparent manner. This definitely seems a step in the right direction for borrowers – but what is good for consumers may not be so for the lender. Let me take a dig at why I believe that existing borrowers should transition if their lenders have not introduced ‘frictions’ in the process.
It was a regular update letter from ICICI Bank informing that our interest rate has been revised (mercifully!) downwards – something that we had expected given the falling interest rate regime. However, what caught our attention was a statement that we could shift to repo-linked rate from our current MCLR regime on payment of conversion charges and visiting the local branch. While I consider myself a savvy planner of our personal finances, but this was one such regulatory change which I had missed. We looked at the rate comparison which suggested that we are paying almost three-quarter of a percentage point extra on our loan and thus the switch seemed no-brainer. I tried calling the customer care but given the limited operations due to pandemic, my call never got through and we satisfied ourselves by dropping a mail to customer care waiting for their revert.
A couple of months later (no revert yet from customer care and I got more occupied tracking the covid graph than interest rate chart), we got another update suggesting that interest rate on our loans had further dropped – I quickly calculated the loss we suffered due to not switching and became determined to get it done. After a quick call to the relationship manager to confirm the process and a long wait in the queue at branch (despite soaring Covid graph, large number of people had flocked to the branch), I could finally submit my request and now waiting for a lower EMI to hit the account next month : ) Btw, contrary to my initial impression that most of the turnout at branch must be for the conversion only, I realised it was to inquire about or actually reviving the loans as limited period moratorium offer is ending soon!
Now the more informative aspect of why I think it makes sense to switch to repo-linked rate. Firstly, in most cases you would start getting the benefit of interest savings from immediate effect given the difference between MCLR and Repo linked rates – even accounting for conversion charges. Secondly, there was an expectation of further rate cut in last MPC meeting held few days back, though it has not been implemented RBI has hinted at accomodative stance after delivering a cumulative reduction of 2.5% over last 18 months bringing repo to 4%. With economy far from recovery currently, the direction is unlikely to be changed any time soon. Thirdly, whenever the direction changes both MCLR and repo linked rates will change. It will be stupid to assume that since speed of transmission has been slower on the way down, it would remain so on the way up as well. While I agree that it would be more swift in case of repo as its in a way automatic, but banks have their quarterly performance being closely tracked so they would not miss an opportunity to improve their NIMs by holding on to MCLR reset.
Infact I think there are certain frictions to deter the borrowers from switching such as branch visits (not possible to submit request over mail or through account) or what I have read regarding the way installments are being calculated under Repo-linked loans by certain lenders – the principle amount is equated over the tenor and interest is allowed to fluctuate based on outstanding and rate thus leading to higher installment in initial years. While the latter is even more beneficial as leads to lower interest outflow overall but can cause cash flow mismatches for certain borrowers and may not be preferred.
I would think its better to switch to the a more transparent regime without much worrying about the volatility it may because if there is one thing that the current pandemic has taught all of us – it is to embrace volatility and focus on present!