Why MCLR may require a review

Just two months after the RBI replaced the erstwhile base rate system with the new marginal cost of funds-based lending rate (MCLR), the central bank is talking of reviewing the implementation of the new framework. This is understandable since legacy issues, varying reset periods (for lending rates) and moves by banks to tinker with the mark-up (spread) on MCLR to tweak the final lending rate have been deterring a full pass through of lower rates under the MCLR framework.

To ensure better transmission and transparency of rates, the RBI introduced the MCLR framework, under which banks have to calculate their cost of funds based on the latest rates offered on deposits or borrowings. This was to ensure that changes in deposit rates were immediately reflected on banks’ cost of funds.

Hence, purely on math, banks were forced to set their benchmark MCLR, 10-20 basis points lower than their base rate in April (when the MCLR rates were first published).

But a lower benchmark rate by design has not ensured lower lending rates. For one, existing borrowers (for loans taken before April 1) continue to be charged interest on loans based on the earlier base rate system. Base rates in the last two quarters have not been reduced, and hence existing borrowers have not seen any relief in lending rates after the MCLR was implemented in April.

Let us take the case of SBI. In April, when the bank had first published its one-year MCLR rate, the lending rate of 9.45 per cent was applicable to new borrowers from April 1. Old borrowers who were charged 9.55 per cent, based on the erstwhile base rate (10 basis points higher than the one-year MCLR then), were still stuck with higher rates.

Even if one had taken a loan under the new MCLR framework, reduction in MCLR month on month, will not benefit all borrowers. This is because unlike under the base rate system, where a revision in base rate was immediately reflected in lending rates of all loans benchmarked against it, under the MCLR-based pricing, lending rates are reset only at intervalscorresponding to the tenure of the MCLR.

In the case of SBI’s home loans, for instance, since the loans are benchmarked against the one-year MCLR, lending rates will only be reset every year.

In May, when the bank cut MCLR across tenures by five basis points, the reduced rate of 9.4 per cent (from 9.45 per cent earlier) was applicable only for new home loan borrowers with effect from May 1. Hence, even if you had taken a loan on April 1 that was benchmarked against MCLR you would not have gained from the five basis points reduction in May.

Different banks following different reset periods for the same category of loans is also an issue.

Axis Bank, for instance, has chosen to peg its home loan rates to the six-month MCLR where lending rates will be reset after every six months.

Different mark-ups on the MCLR has also made it difficult to assess the actual benefit from the new lending rate mechanism. By tinkering with the spread, banks have been able to keep the final lending rate similar to or lower than the prevailing rates.

Bank of Baroda adding a ‘strategic’ premium of 0.25 per cent to its MCLRs, is a case in point. While Bank of Baroda has pegged its one-year MCLR at 9.4 per cent — 25 basis points lower than its current base rate — adding a premium (0.25 per cent) to the MCLR has offset the reduction in MCLR.

The real intention of the RBI to move banks to the MCLR framework was to ensure quick pass through of policy rate actions to the borrowers.

While the MCLR has gone a step ahead, forcing banks to take the latest tweaks in deposit rates into account while setting the benchmark-MCLR rate, some of the issues mentioned have impeded the new lending rate norms from making a real impact on the final lending rate.

It is likely that in the coming months, the RBI will seek to settle some of these issues.