State Bank of India has upped its benchmark lending rates by 1025 basis points, following the 25-bps increase in the policy repo rate
- February 16, 2023
- Posted by: OptimizeIAS Team
- Category: DPN Topics
State Bank of India has upped its benchmark lending rates by 1025 basis points, following the 25-bps increase in the policy repo rate
Subject: Economy
Section: Monetary Policy
Concept:
- MCLR, was instituted by the RBI with effect from April 1, 2016
- The marginal cost of funds-based lending rate (MCLR) refers to the minimum interest rate of a bank below which it cannot lend, except in some cases allowed by the RBI.
- It is an internal benchmark or reference rate for the bank. MCLR actually describes the method by which the minimum interest rate for loans is determined by a bank – on the basis of marginal cost or the additional or incremental cost of arranging one more rupee to the prospective borrower.
- It is applicable to fresh corporate loans and floating rate loans taken before October 2019
Reasons for introducing MCLR
RBI decided to shift from base rate to MCLR because the rates based on marginal cost of funds are more sensitive to changes in the policy rates. This is very essential for the effective implementation of monetary policy. Prior to MCLR system, different banks were following different methodology for calculation of base rate /minimum rate – that is either on the basis of average cost of funds or marginal cost of funds or blended cost of funds. Thus, MCLR aims
- To improve the transmission of policy rates into the lending rates of banks.
- To bring transparency in the methodology followed by banks for determining interest rates on advances.
- To ensure availability of bank credit at interest rates which are fair to borrowers as well as banks.
- To enable banks to become more competitive and enhance their long run value and contribution to economic growth.
Calculation of MCLR
The MCLR is a tenor linked internal benchmark (tenor means the amount of time left for the repayment of a loan). The actual lending rates are determined by adding the components of spread to the MCLR. Banks will review and publish their MCLR of different maturities, every month, on a pre-announced date.
The MCLR comprises of the following:
a) Marginal cost of funds which is a novel concept under the MCLR methodology comprises of Marginal cost of borrowings and return on net worth, appropriately weighed.
i.e.,
Marginal cost of funds = (92% x Marginal cost of borrowings) + (8% x Return on net worth)
Thus, marginal cost of borrowings has a weightage of 92% while return on net worth has 8% weightage in the marginal cost of funds. Here, the weight given to return on net worth is set equivalent to the 8% of risk weighted assets prescribed as Tier I capital for the bank. The marginal cost of borrowing refers to the average rates at which deposits of a similar maturity were raised in the specified period preceding the date of review, weighed by their outstanding balance in the bank’s books.
i.e,
Rates offered on deposits of a similar maturity on the date of review/ rates at which funds raised x Balance outstanding as a percentage of total funds (other than equity) as on any day, but not more than seven calendar days prior to the date from which the MCLR becomes effective.
b) Negative carry on account of’ Cash reserve ratio (CRR)- Negative carry on the mandatory CRR arises because the return on CRR balances is nil. Negative carry on mandatory Statutory Liquidity Ratio (SLR) balances may arise if the actual return thereon is less than the cost of funds.
c) Operating Cost associated with providing the loan product, including cost of raising funds, but excluding those costs which are separately recovered by way of service charges.
d) Tenor Premium–The change in tenor premium cannot be borrower specific or loan class specific. In other words, the tenor premium will be uniform for all types of loans for a given residual tenor. Banks may publish every month the internal benchmark/ MCLR for the following maturities:
- Overnight MCLR,
- One-month MCLR,
- Three-month MCLR,
- Six month MCLR,
- One year MCLR.
- MCLR for any other maturity which the bank considers fit.
Banks have the freedom to offer all categories of advances on fixed or floating interest rates. Banks have to determine their actual lending rates on floating rate advances in all cases by adding the components of spread to the MCLR. Accordingly, there cannot be lending below the MCLR of a particular maturity, for all loans linked to that benchmark. Fixed rate loans upto three years are also priced with reference to MCLR.
However, certain loans like Fixed rate loans of tenor above three years, special loan schemes formulated by Government of India, Advances to banks’ depositors against their own deposits, Advances to banks’ own employees etc. are not linked to MCLR.
Base Rate vs MCLR
Base rate calculation is based on cost of funds, minimum rate of return, i.e margin or profit, operating expenses and cost of maintaining cash reserve ratio while the MCLR is based on marginal cost of funds, tenor premium, operating expenses and cost of maintaining cash reserve ratio. The main factor of difference is the calculation of marginal cost under MCLR. Marginal cost is charged on the basis of following factors- interest rate for various types of deposits, borrowings and return on net worth. Therefore MCLR is largely determined by marginal cost of funds and especially by deposit rates and REPO RATE.
Impact:
As a result of the increase in MCLR, borrowers who have taken home, vehicle, and personal loans will find their equated monthly instalments (EMIs) rising in the coming months.
MCLR-linked loans had the largest share (53.1%) of the loan portfolio of banks as of December 2021.The rise in MCLR will cause resetting such loans at higher rates, due to the rise in WALR(weighted average lending rate) on outstanding rupee loans more than the policy repo rate cuts during the EBLR period.
Note: MCLR is one of the internal benchmark lending rate
External Benchmark Lending Rate-
To ensure complete transparency and standardization, RBI mandated the banks to adopt a uniform external benchmark within a loan category, effective 1st October, 2019. Unlike MCLR which was internal system for each bank, RBI has offered banks the options to choose from 4 external benchmarking mechanisms:
- The RBI repo rate
- The 91-day T-bill yield
- The 182-day T-bill yield
- Anny other benchmark market interest rate as developed by the Financial Benchmarks India Pvt. Ltd.
When the RBI hikes the repo rate, EBLR will go up and vice-versa.