Benchmark:

Home Loan rate of interest offered to you is not a standalone number. It’s a mathematical outcome of a fixed and a variable component.

The variable component is the benchmark to which your loan is linked to by way of a margin or discount.

The benchmark, since 2019, in case of most banks is an External Benchmark (EB) like the RBI REPO rate or Government of India Treasury Bill rates. Some banks link the external benchmark to their respective internal benchmark called the External Benchmark Linked Rates (EBLR). This EBLR then in turn gets linked to the lending rate by way of a margin or discount.

The fixed component is the margin or discount also known as the spread.

Let’s look at these components in detail

Variable Component: The External Benchmark (EB) or the External Benchmark Lending Rates (EBLR) are usually the variable in case of the lending equation of the banks. The Reserve Bank of India (RBI) keeps changing their Benchmark (REPO) based on the inflation & growth numbers prevalent in the country.

Fixed Component: The margin or discount also known as the spread is usually constant throughout your tenure in case of banks. The spread offered to individual customers could be different as it is based on factors like the loan amount, product, female ownership, salaried or self-employed, Cibil score etc. Once the spread is decided at the time of loan sanctioning the same will usually be maintained constant throughout your tenure.

Let’s hear directly from the horse’s mouth on the variable & fixed component. Read Point No 5 - Determinants of Floating Rates - RBI FAQ’s

Evolution of benchmark rates w.r.t lending rates:

The Reserve Bank of India, in the year 2019, mandated the linkage of interest rates to either an External Benchmark (EB) or External Benchmark Lending Rates (EBLR). The banks until then used their internal benchmark to link the lending rates. The calculation of these internal benchmarks is not easily understood by the common folks.

The schematic representation of the evolution is as follows

Benchmark Prime Lending Rate – BPLR – Used by banks from 2003 to 2010. However, the same was being used from 1990 till 2003 in prior versions. Finally, in 2010 RBI introduced the Base Rate mechanism.

Base Rate – This benchmark was used by Banks from 2010 to 2016 and finally gave way to MCLR.

MCLR – Marginal Cost of Funds linked Lending Rate - It came into effect from 1^st April 2016 and is in force even now. However, new loans are not given on the basis of MCLR and most banks have shifted to the new regime of EBLR from 2019.

External Benchmark (EB) or External Benchmark Lending Rates (EBLR) – The external benchmark being the RBI REPO and Government of India Treasury Bills. This was introduced in 2019 and most banks have started lending with reference to the RBI REPO as the external benchmark. A few of the banks keep the Treasury Bill rates as the external benchmark.

Rationale of introducing External Benchmark (EB) by RBI:

External Benchmark (RBI REPO) cannot be influenced by individual banks and it’s at the sole discretion of RBI. The benchmark rates and their upward or downward movement is decided only by RBI.

On the contrary, the various internal benchmarks used by banks were decided by them and not necessarily in direct correlation with the external benchmark (REPO). The Internal Benchmarks had a dual relationship with your lending rates over the last few decades until 2019 when RBI mandated the usage of External Benchmark (EB).

The internal benchmarks had a dotted line & solid line relationship with your interest rates.

Solid Line Relationship: Whenever RBI increased the REPO rates the solid line relationship was deployed. If RBI increased the REPO by 0.25% your rate would also increase by 0.25%. 

Dotted Line Relationship: Whenever RBI decreased the REPO rates the dotted line relationship was deployed. If RBI decreased the REPO by 0.25% your rate would decrease by only 0.1% or not decrease at all. Since the lines were dotted the remaining 0.15% or the full 0.25% cut could not reach you.

It took RBI a few decades to streamline the solid/dotted line relationship banks had with the interest rate of their customers to a solid line relationship. In 2019, RBI mandated the linking of lending rates to an External Benchmark (EB) with the assumption that this mechanism will compel the banks to pass on the benefits of External Benchmark (EB) rate reduction immediately to their customers.

This pretty much solves the problem and there can only be a simple solid line correlation of RBI REPO & your rates as these external benchmarks cannot be influenced by individual banks.

It cannot get more transparent than this. RBI REPO is the variable in the equation and changed by RBI. The margin is the constant part of the equation. So, your rate will change as and when the RBI REPO changes and by the same proportion.   

You get an inbuilt safety net.