Behind the Reserve Bank of India’s (RBI) pause in interest-rate hikes was the fear that a further rise in home loan pricing would put borrowers under extreme stress.

The RBI’s decision to plot a new course in its first monetary policy for FY2024 after six straight rate hikes was also driven by the fear that a deep stress in retail loans could pose a systemic risk. A further rise in borrowing cost for buying a car or taking other personal loans could turn tricky. Also feeling the heat were the small and medium-sized enterprises (SMEs).

While growth concerns weighed heavy when the RBI decided in favour of keeping the repo rate unchanged in its April bi-monthly policy, the high interest rate on retail loans also played an important part.

Ahead of the monetary policy, the RBI called for a series of meetings with bankers to explore ways on how to keep the retail loan rates insulated from frequent rate hikes. The discussion was also on SME loans. The regulator was uncomfortable with the way the external-benchmark linked loan rates were ballooning. 

“RBI called for meetings to discuss on the interest rate scenario, particularly regarding retail and SME loans. The retail and SME loans are linked to the external benchmark. This works well for borrowers when the interest rates are falling. But when they are continuously rising, it becomes difficult for the borrowers to allocate more money for their EMIs (equated monthly instalments) and loan repayments,” said a senior banker who did not want his name to be revealed. 

With the RBI increasing the repo rate by 250 basis points to 6.50% since May 2022, banks have passed this on to certain loans which are linked to the external benchmark interest rates. Effectively, the policy has been tightened by 290 basis points with a 40-basis point increase when the standing deposit facility (SDF) was introduced.

A deep swelling in bad retail loans can hurt the banking system. As per RBI data, out of the total bank credit of Rs 134.15 lakh crore, retail loans constitute about Rs 40.13 lakh crore. A substantial chunk of the retail credit comes from the home loan segment.

Bankers said the home loan portfolio could have come under severe stress if the RBI had not put brakes on the rate-hiking cycle. Borrowers have already seen their home loans move from as low as 6.4% to even double-digits now. For the State Bank of India (SBI) borrowers, the home loan rates now vary between 9.15% and 11.30%. Private lender ICICI Bank has home loans varying between 9.25% and 10.05% while for Axis Bank borrowers it is from 8.45% to 10.30%.

“Loans linked to external benchmark, including borrowing to buy a house, are getting repriced at a fast pace as RBI has raised repo rates over the last 11 months to combat inflation. A customer sourcing home loan at 6.4% was preparing his repayment schedule around those levels. Now the borrower is under some stress and this is creating repayment issues,” the head of a bank said.

The Reserve Bank had earlier nudged the banks to get into a system where certain loans, including retail, are linked to external benchmarks like the repo or the treasury bills to bring about a transparency in pricing. Prior to the external benchmark-based lending rate (EBLR), the loans were linked to the marginal cost of funds-based lending rates (MCLR) where the cost of the loans are dependent on the cost of funds for the bank. In the EBLR regime, the repo rate changes are translated into the pricing of the loans.

“One of the reasons why the RBI paused interest-rates in its latest policy review is due to the stress in various pockets of retail and SME loans,” said a banker.

Borrowers are worried about the steep rise in EMIs they have to pay on their home loans. Banks have provided some cushion by extending the tenure of the home loans without bloating the EMIs. The RBI has allowed the loan tenure to be extended to the borrowers being 75 years of age. Many banks are thus extending the home loans to the maximum tenure possible.

Rates do not go up uniformly across banks. In some banks, the retail prime lending rate (RPLR) is repo rate plus the spread which are premiums that they charge on the loans. For some banks, the spreads are 2.75% or 3% depending on their internal margin targets.

“The pricing of debt has been a concern for regulators. The RBI was always pushing for a seamless and more transparent system of transmission of rates. But in a rising interest rate scenario, the consumers are stressed. This could lead to delinquencies,” said Parijat Garg, a digital lending expert and former senior vice president of credit bureau CRIF.