RBI group to study MCLR regime so that your bank reduces loan rate

(From left) RBI deputy governors N S Vishwanathan, Viral Acharya and RBI Governor Urjit Patel at a press conference on monetary policy review in Mumbai (Photo: Kamlesh Pednekar)
Voicing displeasure over banks not doing enough to reduce lending rates, the Reserve Bank of India (RBI) said an internal group would review the working of the system to improve transmission. The central bank will also explore ways to link bank lending rates directly to market-determined benchmarks.

Though the marginal cost of funds-based lending rate (MCLR) system is an improvement over the base rate system, monetary transmission by banks has not been “not entirely satisfactory”, the RBI said in statement on developmental and regulatory policies.

“The decision to review the MCLR system with a view to improve monetary policy transmission is a welcome move as a large section of any bank’s portfolio is still anchored to the base rate. The MCLR in its present form is grossly misused by a few players to create an artificial pricing structure,” said R P Marathe, managing director and chief executive, Bank of Maharashtra.

The MCLR was introduced in April 2016 for improving the monetary transmission. The MCLR, the internal benchmark lending rates, have to be revised monthly. This move was in response to banks failing to transfer the benefit of rate cuts by the RBI to its customers. The MCLR rates, unlike base rates, have to take the change in repo rates into consideration and revise lending rates accordingly. 

However, the RBI said the base rate of some banks continued to be significantly less than the MCLR, even after the introduction of the new system. While the extent of change in base rate may not necessarily mirror the revision in MCLR, the rigidity of the base rate deters efficient transmission of monetary policy to the real economy. 

The monetary policy for August cut the repo rate by 25 basis points (bps) to six per cent. The RBI had started to soften repo rate from January 2015 and has brought it down by 200 bps since then. 

Banks in India had aggressively cut lending rates in January 2017 due to inflow of cheap money into deposits after demonetisation and the resultant reduction in the cost of funds.  

The repo rate for April 2015 was 7.5 per cent and had seen a reduction of 150 bps to date. During the same period, banks have cut their MCLR by 70-270 bps with public sector banks making the biggest rate cuts. During the same period, the base rate has been cut much less. For example, State Bank of India has reduced its base rate from 9.85 per cent in April 2015 to 9 per cent in July 2017.

Bankers said the decision to revise rates was based on a formula set by the RBI with limited room for discretion.

Since a large part of the floating rate loan portfolio of banks is still anchored in the base rate, the RBI plans to explore various options in the near future to link the base rate to changes in the cost of funds for banks.

The RBI study group will look at various aspects of the MCLR system from the perspective of improving monetary transmission and exploring linking of the bank lending rates directly to market-determined benchmarks. It will submit the report by September 24.

CRISIL in a report said transmission remained on course. The liquidity in the banking system had stayed in the surplus zone, facilitating a swifter transmission of interest rate cuts across instruments. 

So far in the current easing cycle starting January 2015, the repo rate has been reduced by 200 bps, while rates on commercial paper (CP) and certificates of deposit (CD) have also fallen by the same extent. In level terms, too, rates offered on these papers were closer to the repo rate. That suggested monetary transmission was happening. However, there continued to be some rigidity in bank lending rates, CRISIL said.

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