Cheap Home loans everyone! Let's rejoice

In today's newsletter, we will be talking about SBI's plan to offer cheap loans and the auto slowdown

The Story

On Monday we had some breaking news when State Bank of India announced that it was going to cut one-year marginal cost-based lending rates (MCLR) by 10 bps (0.1%) — to 7.9% from 8%. The new rates will be effective from December 10 and with this one single move, home, auto and other retail loans will now be cheaper.

However, the words one-year MCLR make it seem like there’s something else happening here besides just cheap home loans. So instead of leaving this story as is, we will try and decipher the mysterious MCLR and everything else that goes with it.

Who are you MCLR?

Home loans have long repayment periods. Often times they could last as long as 30 years and a lot can change between now and 2050. So banks and customers could both do with a little bit of flexibility. The MCLR aims to do just that. Unlike fixed interest rates, MCLR — the Marginal cost of lending rate, is flexible. Meaning they change as time goes by. But the way this works is — Banks first calculate a minimum interest rate (MCLR) below which they can’t lend. This rate is largely determined by the bank's cost of funding.

This cost of funding metric isn’t as straightforward as one might think. Banks borrow from multiple sources. They borrow from the RBI. They borrow from banks. They borrow from other large institutions. Most importantly they borrow from you lot — by way of mobilising deposits. You add the cost of borrowing here (mostly the interest rate at which the bank borrows or the interest rate on the deposits they offer you), throw in some extra points if you are raising money for long durations, take into account some other related expenses and you get the MCLR. It's a neat little formula. But if it so happens that the banks find that their cost of funding keeps dropping as time goes by, they will inevitably choose to reduce their MCLR as well. And on the flip side, if they see that their cost of funding keeps rising with time, MCLR goes up in tandem.

So, in essence, it’s flexible.

But once you borrow from the bank at a certain MCLR they only review it after a fixed time period. So if you were to borrow from SBI today at an MCLR of 8% and say the bank decides to cut MCLR by 0.25% over the next 3 months. You will only see the benefit accrue to you after 12 months i.e. the review happens once every year (or six months) and until then you’ll be at an MCLR regime of 8%. This is why they call it a 1-year MCLR.

Now at this point, it’s also important to remember that the RBI has been cutting interest rates for quite some time now and the hope was that banks would soon follow suit. However, things haven't been going according to plan. Despite large rate cuts from the RBI, banks have only marginally reduced their interest rates. Now the banks contest that despite RBI’s rate cuts their cost of funding hasn’t gone down drastically, which means they can’t offer to drop interest on home loans. However with SBI taking the lead with the 8th cut in MCLR this year, maybe things will finally take a turn.

What’s happening with the Auto Slowdown?

You know what’s funny. The fact that we don’t hear about the auto slowdown every single day anymore. It has been a while now since I have personally read anything about the auto industry and it got me thinking — Are we finally on the brink of a turnaround? Is the automobile slowdown finally coming to a close? Have we finally turned a corner?

Well... Not really.

For the uninitiated, auto sales in October did see some revival. But that hope quickly vanished after Honda, Tata Motors, and Hyundai reported a decline in their November sales compared to last year. Now it's possible that the decline in sales could be attributed to the base effect. Last year the people celebrated Dhanteras in November. This pushed sales number quite a bit. So it would have been a real challenge for automakers to outdo sales from last November considering we celebrated the festival of lights in October this year.

In any case, the fact of the matter is sales numbers are down once again and despite the lack of news on this front, there’s no reason to celebrate, at least not yet.

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