MCLR -Marginal Cost of Funds Based Lending Rate
MCLR, Marginal Cost of Funds Based Lending Rate System interest regime came into effect on April 1, 2016. This was a refined version of Base Rate system announced by RBI to further enhance the transparency of credit interest rate and ensure better transmission of policy change. While banks were required to adopt MCLR system for new customers, they were given freedom to continue existing loans linked to BR/BPLR, till maturity or till migration of such loans to MCLR based rate on mutually agreed terms
Computation methodology of MCLR rate
MCLR rate is arrived by banks by considering
a. Marginal cost of funds [= 92% of Marginal Cost of Deposits and Other Borrowings + 8% of Return on Net Worth]
b. Negative carry on CRR
c. Operating cost
b. Tenor Premium/ Discount
MCLR Rate = a+b+c+d
The lending rate under MCLR regime is calculated as below:
Lending interest rate = MCLR for the tenure + Business strategy Premium + Credit Risk Premium.
Conditions to be satisfied by Banks in relation to MCLR rate
1. Banks must announce MCLR rates for different tenures linked to marginal cost for said tenures. This was an improvement over Base Rate as it is more sensitive to changes in policy rates. In tune with the directions, banks are announcing overnight, one month, three months, six months and one year MCLR rates. Certain banks like SBI are announcing two years and three years MCLR too.
2. The MCLR rate must be renewed at monthly frequency on pre-announced date. New loans or renewals of existing loans after the announcement should be linked to the new rate.
3. Reset period must be specified at the time of sanction of loan itself. For floating rate loans, maximum reset period must be one year
4. Fixed rate loans above three years are exempt from the purview of MCLR.
Did MCLR rate perform as envisaged by RBI?
MCLR rate succeeded in interest rate transmission to some extent in the case of new loans, but failed in respect of existing loans. The major shortcomings associated with MCLR are
a. No sunset clause was fixed for migration of existing BPLR/BR based loans to MCLR and banks preferred to continue with BPLR/BR linked loans as the rate of interest was higher compared to MCLR rate
b. Certain banks that permitted migration continued to charge same interest rate in BPLR/BR system even after shifting to MCLR by increasing the spread, thus denying any reduction immediately following shifting. Further, banks did not popularize migration as it was observed to affect their profit.
c. Banks offered lower rates to new customers but did not bother to lower the interest rate applicable to existing customers. Thus, new customers were incentivized at the cost of existing customers.
d. Banks were permitted to charge for shifting old BPLR/BR lined loans to MCLR.
The recent announcement by RBI to link interest rate to external benchmark is to empower borrowers to have better comparison and ensure better transparency. Though the guidelines were to be released by December 2018, the same has not been released and the implementation is likely to be delayed. RBI is learnt to be reassessing the challenged faced during previous interest rate regimes. Meanwhile, SBI has announced the decision to link SB interest rate and lending under Cash Credit/ Overdraft facilities (both above Rs. 1 lakh) to external benchmark Repo Rate, effective from May 1, 2019.
