The State Bank of India (SBI), the country’s largest bank, is adopting a new method to let it’s lending rates move in tandem with the repo rate in the future. The concern was that whenever the RBI cut the repo rate earlier, the banks took time to pass on the benefit to the borrowers and there was always a time lag in lowering their lending rates.
The movement in the repo rate did not reflect in the movement of the lending rates and this made the RBI announce that the lending rates of banks should be linked to an external benchmark as against the practice of using Marginal Cost of Funds-based Lending Rate (MCLR), which is the bank’s internal benchmark. This, however, didn’t materialize and the RBI had to keep the directive in abeyance till further notice. Only a few banks do have home loans linked to an extremal benchmark.
SBI’s new approach
Still, keeping the external benchmark in context, the SBI adopted a novel way. The SBI announced that it is going to link its savings deposits’ interest rates and short-term loans to the RBI’s repo rate. So, instead of linking the lending rates to an external benchmark, the SBI has linked the deposit rates to an external benchmark. In doing so, this is the premise – In a falling interest rate scenario (as and when the repo rate falls), there will be equal pressure on deposit rates to fall and with the cost of funds coming down, the lending rates too will fall.
If the move finds success, other banks may also adopt it over time as it remains to be seen which other banks will follow suit and replicate the SBI model. Overall, the effective transmission of the repo rate could be witnessed. In a falling interest rate scenario, this will help borrowers in terms of lower EMIs while the reverse will happen when the rates rise.
The new rates for SBI, linked to the external benchmark rate, would be effective May 1. Currently, loans are linked to the bank’s cost of funds which is largely reflected through its internal benchmark Marginal Cost of Funds based Lending Rate (MCLR) declared by the bank every month. The banks get the flexibility to manage their Asset-Liability Management (ALM) better than before.
Importantly, SBI home loan will continue to be linked to its MCLR and not to any external benchmark. Only the interest rates on the savings account will be impacted, which will have an impact on lending rates over time.
Interest rate on the savings bank account
Currently, the savings bank account of SBI carries an interest rate of 3.50 percent for deposits up to Rs 1 crore and 4 percent for deposits above Rs 1 crore. However, going forward, only deposits in savings account above Rs 1 lakh will be impacted and will henceforth carry a flexible interest rate. Savings account balance below Rs 1 lakh will continue to carry the fixed rate of interest of 3.5 percent.
Small depositors with a balance less than Rs 1 lakh will not get hurt and they will continue to get a fixed rate of interest on the saving account balance. Also, borrowers with cash credit accounts and overdraft limits up to Rs 1 lakh will remain outside the linkage to the repo rate.
Your home loan EMI is primarily a function of the bank’s cost of funds reflected in the MCLR of each bank. In order to lower the lending rate, a bank has to bring its MCLR down, which means paying less interest to its depositors. It remains to be seen how the SBI’s new move to link the interest rate on savings deposits to the repo rate brings down its cost of funds, leading to lowering of EMIs. Remember, in time of rising interest rates, the EMIs may shoot up equally fast.