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RBI asks banks to link base rate to MCLR by April 1 for quicker transmission of interest rates

The MCLR for 1-year tenure loan for SBI is at 7.95 percent in January 2018 while its base rate still stands at 8.65 percent.

February 07, 2018 / 09:02 PM IST
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From April 1, banks will have to link the base rate with the MCLR in order to ensure quicker transmission of policy rates to existing loan interest rate to borrowers, the Reserve Bank of India said on Wednesday.

RBI introduced the Marginal Cost of Funds based Lending Rates (MCLR) system with effect from April 1, 2016 to facilitate greater passing on of the benefit of reduction in policy rates to lending rates.

The base rate regime (loans taken before April 1, 2016) led to slower pass through.

The MCLR for 1-year tenure loan for country's biggest lender State Bank of India (SBI) stands at 7.95 percent for the month of January 2018 while its base rate still stands at 8.65 percent.

The 1-year MCLR for most commercial banks as on January 2018 ranges between 7.95 percent and 9.75 percent.


“With the introduction of the MCLR system, it was expected that the existing Base Rate linked credit exposures shall also migrate to MCLR system,” RBI said in the statement on Developmental and Regulatory Policies.

It is observed, however, that a large proportion of bank loans continue to be linked to the Base Rate despite the RBI highlighting this concern in earlier monetary policy statements.

“Since MCLR is more sensitive to policy rate signals, it has been decided to harmonise the methodology of determining benchmark rates by linking the Base Rate to the MCLR with effect from 1 April 2018,” the central bank said.

RBI deputy governor N.S. Vishwanathan said, “We have been mentioning in the earlier policy that we are concerned about inadequacy of monetary transmission to the base rate and about large number of accounts still being under the base rate regime.”

Clarifying that the RBI is harmonizing and not equalizing the MCLR with base rat, he added, “We are now harmonising the calculation of base rate with the MCLR so that the responsiveness of the credit portfolio to monetary policy signals is not hindered by interest rate on large part of bank portfolio being linked to base rate.”

The MCLR was introduced, under the leadership of former RBI governor Raghuram Rajan in another attempt, to calculate the benchmark lending rate in a way that ensures banks pass on policy rate cut benefits to borrowers in a quicker and more transparent manner.

Previously, under the base rate and BPLR (benchmark prime lending rate), banks were following individual methodologies for computing the minimum rate at which they could lend.

Under the MCLR, RBI asked all banks to follow the marginal cost of funds method to arrive at their benchmark lending rate.

MCLR is calculated after factoring in banks’ marginal cost of funds (largely, the interest at which they borrow money), return on equity (a measure of banks’ profitability), and negative carry on account of cash reserve ratio.

The RBI will issue necessary instructions in this regard by the end of next week.

The banking regulator has, on several occasions, pulled up lenders for their “arbitrariness” in calculation lending rates keeping them high and flagged concerns over weaker monetary transmission.

In the previous policy, it announced that an internal RBI group also suggested switching over to external benchmarks in a time-bound manner so that better rates are available to borrowers.

The group, headed by Janak Raj, suggested three external benchmarks --- a risk-free curve involving T-Bill rates, the CD rates and the Reserve Bank’s policy repo rate.

In its report, the panel observed that internal benchmarks such as the base rate and MCLR have not delivered effective transmission of monetary policy.

It has also suggested that lending rates should be reset once every quarter, from the current practice of once a year.

On Wednesday, in the sixth bi-monthly monetary policy 2017-18 on Wednesday, the RBI kept the key policy repo rate unchanged at six percent, after 2-day deliberations by the monetary policy committee (MPC) headed by RBI Governor Urjit Patel.
Beena Parmar

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