Banks shifting to MCLR system from base rate regime

Source: The Hitavada      Date: 06 May 2018 09:15:35


By Sudhakar Atre,

AT PRESENT interest rates on most of the bank loans linked to the base rate of individual banks. It is expected that when RBI reduces the repo rate ( i.e. the rate at which RBI lends money to Scheduled Commercial Banks (SCBs) they will also reduce their lending rates. But, in reality the banks are either reluctant to cut their lending rates or did not do so immediately after the reduction of repo rate by RBI. There are genuine reasons for that, but the fact remains that benefits are not passed on to borrowers under present Base System.

To address this issue a new method of bank lending called Marginal Cost of Funds Based Lending Rate (MCLR) was introduced by RBI w.e.f. 1st April 2016. It was expected that the banks will shift from existing Base Rate System to MCLR system slowly. However, the progress in this is not up to the desired level.

The regular readers of this column may recollect my article ‘Concept of Marginal Cost of Funds Based Lending Rate (MCLR)’ published in Cityline of The Hitavada Nagpur on August 21, 2017 wherein the concept of MCLR was explained in detail. It was mentioned in that article itself that while releasing Statement on Developmental and Regulatory Policies issued on 2nd August 2017 RBI announced to form an Internal Study Group to study the various aspects of the MCLR system from the perspective of improving the monetary transmission and exploring linking of the bank lending rates directly to market determined benchmarks.

Now, based on the report of the committee, RBI in its recent Statement of Development and Regulatory Policies issued on 7th February 2018 asked all SCBs to harmonise the system of determining benchmark rates by linking the Base Rate to the MCLR with effect from April 1, 2018. But, it seems that both the base rate and the MCLR will co-exist for some time. However, the computation of the base rate will be linked to the MCLR.

It means the base rate will automatically increase or decrease with increase or decrease in MCLR without any specific action required for adjustment. This will benefit the existing borrowers whose loans are still linked to the base rate.

The main determinants of MCLR of a particular bank are a) Marginal cost of funds of that bank b) Operating Cost of the Bank. a) Marginal cost of funds: This is the cost of funds of individual bank which mainly consist of its deposits, borrowings and return on capital. We all are aware that banks have to pay interest on deposits to its customers similarly if bank borrows from RBI it has to pay interest to RBI at prevailing repo rate. In simple terms if bank pays higher ROI on its deposits or RBI increases the repo rate, marginal cost of funds will be higher for that bank. Naturally, marginal cost of funds will be lower for banks with more low cost deposits like current account and savings accounts (CASA).

Secondly, many times banks have to borrow from RBI for their short term requirement and have to pay interest on these borrowings as per prevailing repo rate. Third factor is the return on net worth in accordance with capital adequacy norms. In fact this is related to the bank’s ability to raise its capital at low rate.

b)Operating cost of the bank: This includes various expenses incurred by bank to run its operations like salary of staff, establishment cost, payment for maintaining IT infrastructure etc., and included in MCLR. So, banks with low operating costs can offer lower MCLR. In addition to this every bank has to maintain funds with RBI in the prescribed ratio which is called as Cash Reserve Ratio (CRR). If the RBI decides to increase the CRR, the available amount with the bank for lending comes down. The RBI uses the CRR to drain out excessive money from the system. At present this is 4% of net term and demand deposits (Liabilities) of bank. RBI does not pay any interest on it. Hence, it is always better to know for borrower the condition of the particular bank which governs its MCLR. To illustrate, presently MCLR of SBI is @ 8.15% for 1 year, 8.25% for 2 years and 8.35% for 3 years. MCLR of BOI is 8.40% for 1 year. It is better to check prevailing rates as they may change. However, rate of interest charged by bank on loan includes MCLR plus business strategy risk plus credit risk premium. So, banks may charge only MCLR for housing loan to borrowers with low risk score.

It will be too early to comment whether the borrowers will be benefited by this shifting of base rate system to MCLR system, as we will have to wait for some time. But, for the borrowers who have already availed loan at base rate it will be better for them to revisit and check with their banks what will be beneficial for
them and ask for the change accordingly.

(The author is a freelance writer on banking. He can be
contacted on [email protected]