Concept of Repo Linked Lending Rate ( Economy Concept )

Repo Linked Lending Rate

Why in news?

• State Bank of India (SBI), the country’s largest lender, decided to link all the floating rate retail loans and loans to micro, small and medium enterprises (MSME) to the Reserve Bank of India’s (RBI) repo rate, with effect from October 1.

Background:

• The RBI had mandated external benchmark linked interest rate to all banks for faster transmission of monetary policy rate.
• In July, SBI had linked home loans to the repo rate but decided to discontinue the product earlier this month after the RBI came out with guidelines, mandating external benchmark based floating rate products.

• In the earlier repo linked home loan product, only the principal component was equated to the monthly instalment while from October 1, both interest and principal will be equated to monthly instalments.

What will happen to Interest Rates?

• The interest rate of the repo rate linked loan will be below the present structure of MCLR linked loans.
• Linking floating rate loans to repo rate would mean every time there is a change in repo rate, interest rates will change automatically.

Marginal Cost Based Lending Rate:

• At present, interest rates on loans are linked to a bank’s marginal cost of fund-based interest rate, known as the Marginal Cost of Lending Rate (MCLR).
• It came into effect in April 2016.
• It is a benchmark lending rate for floating-rate loans.
• This is the minimum interest rate at which commercial banks can lend.
• This rate is based on four components—the marginal cost of funds, negative carry on account of cash reserve ratio, operating costs and tenor premium.

Difference between MCLR and Repo linked loans: