07 DECEMBER, 2022

There are different base rates by which banks determine the rate of loans. These base rates are declared by India’s central bank, The Reserve Bank of India (RBI). Till 2019, the following rates were used to determine the loans in India.

  • Internal Benchmark Lending Rate (IBLR)
  • Marginal Cost of Funds Based Lending Rate (MCLR)

RBI did not find the internal benchmark rates satisfactory enough to deliver an effective transmission of monetary policy. On the recommendation of an Internal Study Group (ISG), the RBI has decided to switch to an external benchmark. This external benchmark rate is now called the EBLR rate.

Know About the EBLR Full Form

EBLR stands for External Benchmarks Lending Rate. According to the RBI's 5th bi-monthly Monetary Policy Statement (2018-19), floating interest rates for retail loans and micro and small businesses will be linked to EBLR. RBI also announced that further consultations would be held with stakeholders to develop an effective mechanism for transmitting rates.

EBLR in banking is extremely relevant because banks cannot offer loans to customers lower than the EBLR rate. Banks use EBLR to decide the Home Loan interest rate and interest rates of other loans. Therefore, it is crucial to understand the EBLR meaning and the relevance of EBLR in banking.

Instructions Given by RBI for Using EBLR in Banking

Personal loans and other retail loans, as well as loans to small businesses, have floating interest rates based on EBLR. Banks can opt to provide such loans linked to the EBLR to other categories of loans too.

Banks have to follow the same external benchmark for a particular loan category. This has been done so that the borrowers can get transparent, standardised, and easy-to-understand loan products.

The bank can adopt up to one benchmark for any loan category. EBLR is not a new interest rate structure. All banks have to link their Home Loan floating interest rates to the EBLR.

Spread Under External Benchmark

The RBI has allowed lending banks to decide the spread over the EBLR interest rate. However, the credit risk premium the bank charges from the borrower can only be increased when there is a significant change in the borrower’s credit assessment. In addition, the bank can alter other loan components, such as the operating cost, once every three years. Banks need to reset the interest rate under the EBLR a minimum of one time every three months.

Why a Shift from IBLR to EBLR?

Several issues with the IBLR (Internal Benchmark Lending Rate) have led to the shift to EBLR. Some of these have been listed below.

  • When RBI lowered the repo and reverse repo rates, banks only passed on some of the benefits to borrowers. The borrowers were at a loss in such an event.
  • There are several variables in the lending rate. These variables may include the bank’s spread, the bank’s financial overview at that time, and the list of the bank’s deposits and non-performing assets (NPAs).
  • The internal benchmark could not make way for any active change in the effective interest rates as several variables were linked to the IBLR.
  • The need for more transparency in setting up the internal benchmark rates creates roadblocks to the transmission of lending rates.

Benefits of EBLR for the Borrowers and the Banks

The EBLR rate benefits the borrowers and the lending banks in several ways.

  • Banks get the freedom to decide the spread over the EBLR.
  • Since EBLR is an external rate, a policy rate cut activity regarding the lending rates will reach the loan seekers sooner.
  • The interest rate process is more transparent and easier to understand for borrowers.
  • Borrowers can analyse the interest rates charged by various banks. This way borrowers know the profit margin of every bank over the fixed rate of interest, which helps compare various loan options.

How does EBLR impact the borrower’s EMI outgo?

As a result of persistent surplus liquidity conditions, banks reported a significant improvement in transmission based on the increase in outstanding loans linked to external benchmarks.

A Home Loan taken out before October 1, 2019, is most likely to be linked to MCLR. The MCLR Home Loan is linked to a one-year MCLR rate and banks add their own margin/spread on the MCLR rate to get you the final interest rate.

As a borrower, you can switch your Home Loan linked to MCLR to an external benchmark by informing your bank.

The Impact of EBLR on the Economy

The notable increase in EBLR-based lending will lead to a remarkable improvement in the transmission of monetary policy. The monetary policy transmission shows how changes made to the policy rates by the central bank affect various segments of economic activity, like lending and inflation.

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Disclaimer: This Article is for information purpose only. The views expressed in this Article do not necessarily constitute the views of Kotak Mahindra Bank Ltd. (“Bank”) or its employees. Bank make no warranty of any kind with respect to the completeness or accuracy of the material and articles contained in this Newsletter. The information contained in this Article is sourced from empaneled external experts for the benefit of the customers and it does not constitute legal advice from Kotak. Kotak, its directors, employees and the contributors shall not be responsible or liable for any damage or loss resulting from or arising due to reliance on or use of any information contained herein.