According to RBI’s mandate, all lending institutions must link their retail credit options like an MSME loan to any external benchmark from 1st October 2019.
- Statistics from this apex financial institution of India shows that 36 out of 62 lenders have chosen repo rate as their preferred benchmark for lending rate determination.
As an entrepreneur, understanding how this external benchmarking system affects business loans is crucial to assess your liability better.
Understanding external benchmarking system
The rate of interest levied on business loans is calculated based on certain parameters, whereby the benchmark rate concretized the lowest lending rate possible. It is thus the minimum threshold below which lenders cannot sanction credit.
However, they also levy a spread above this benchmark lending rate which is another crucial variable in determining the interest rate on an MSME loan or any other advance. While MCLR is an internal benchmark, lenders can choose one from RBI’s four external benchmarking options.
The Reserve Bank of India introduced this external benchmarking mechanism to replace the existing MCLR system, bringing in increased transparency. Earlier, financial institutions delayed the transmission of policy rate cut benefits to customers.
The external benchmarking system, nevertheless, ensures that any cut or hike in key policy rates reaches borrowers promptly. Customers also stay informed about the profit margin, i.e. spread, which makes comparison simpler and transparent.
Note that the system is primarily applicable to floating interest rates. Lenders also need to reset these rates according to their external benchmark within 3 months of key policy rate changes.
- As declared in the bi-monthly monetary policy released on 4th December 2020, the current repo rate stands at 4%.
How external benchmarking affects MSME loans?
While the external benchmarking system has a remarkable bearing on the liability of MSME financing borrowers, it is best to first understand what is MSME to suitably proceed with an informed decision. MSMEs refer to micro, small and medium enterprises mainly engaged in manufacturing, production, preservation or processing of commodities and other goods. MSME loans are efficient financial solutions for such enterprises, providing the leverage of timely funding to a business.
When availing credit linked to an external benchmark, here is what you shall experience:
- As interest rates are linked to repo rates, a cut in this rate would bring down your EMIs too. However, there can be a steep rise in interest rates if the key policy rate is hiked, which can impact the loan EMIs considerably.
- Known as RLLR or Repo Linked Lending Rate, the external benchmarking-based lending can increase your monthly outflow towards loan repayment with a hike in repo rate. It can create an additional financial burden. In this context, you need to check out some tips to avoid a business financial crisis effectively.
- Loans taken before 1st October 2019 are mostly linked to the marginal cost of funds-based lending rates. If existing borrowers are willing to switch to the new external benchmarking mechanism, they can place a request with their respective lenders. However, the process may be complicated and hassling.
- As lenders enjoy the freedom to impose their profit margin, you may end up paying a higher rate of interest on such financing. Thus, when availing an MSME loan, it is best to select a lender offering competitive rates.
While transparency is advantageous for borrowers, increased market volatility can lead to loan defaults. If you aren’t willing to take the risk, choose to approach NBFCs who are exempted from this circular. Today, NBFCs are changing the business loan landscape in India with their attractive loan offers.
- NBFCs witnessed a credit growth of around 26% in March 2020.
Financial institutions like Bajaj Finserv further offer business loans of up to Rs. 30 lakh at competitive rates of interest for improved borrower convenience.
They also bring customised pre-approved offers to simplify the method of availing credit and help save time. These offers are available on various financial products, including business loans, personal loans, etc. Provide details like your name and phone number to check your pre-approved offer online.
Applicants with a CIBIL score of 750 and above and looking for risk-free credit can avail an unsecured business loan from an NBFC. A tailored MSME loan can suitably cover funding needs like expansion, operational expenses, debt consolidation, inventory purchase, etc. adequately.