Retail loans to be linked to external benchmarks from April 1: Here's what it means for you

The Reserve Bank of India (RBI) in its bi-monthly monetary policy committee meeting on Wednesday said that starting April 1, the interest rate on all retail loans, which include home loans, auto loans and loans given to micro and small enterprises, will be linked to external benchmarks.

The external benchmarks suggested by the central bank are repo rate, the 91-day Treasury bill yield or the 182-day Treasury bill yield produced by the Financial Benchmarks India Pvt Ltd (FBIL). The central bank is also letting commercial banks to choose any other benchmark rate produced by the FBIL.

Since April 2016, the interest rates on all the loans have been linked to the Marginal Cost of Funds based Lending Rate (MCLR). Before 2016, they were linked to the base rates of the banks.

It is also possible that the banks can offer non-retail loans linked to external benchmarks. The guidelines on this will be put out by the central bank by the end of this month.

Here's how the announcement will impact your borrowings from next year:

It will help bring in more transparency in the interest rate the bank is charging against the loan. While banks generally make the MCLR changes public, there have been instances when information has failed to reach the borrowers due to lack of communication or awareness.

Banks are usually quick to increase rates whenever the RBI increases them but does not follow suit when the rates are dropped. The new norms will curb instances where borrowers have complained that the MCLR rates were not cut despite the RBI's reduction in repo rate as banks failed to pass on the benefit to the borrowers.

Since repo rates are more reflective of the economy, linking retail loans to repo rates would help borrowers gain the most when interest rates are declining.