‘Marginal’ gains from new lending rates

Starting last Friday, there are a minimum of 450 lending rates floating around in the Indian banking market, a high number by any standard of normal assessment. The Reserve Bank of India had mandated banks to announce and sanction incremental lendings this financial year on what has been called the Marginal Cost of funds-based Lending Rates (MCLR).

Each bank was instructed to announce a minimum of five lending rates corresponding to overnight, one-month, three-month, six-month and one-year tenors, to be reviewed every month. We have upwards of 90 banks and therefore we get about 450 lending rates! People could be pardoned if they say this is a staggering maze.

“An individual ant, even though it has a brain about a millionth of a size of a human being’s, can learn a maze,” writes EO Wilson, the world’s foremost authority on the study of ants. So, even as these rates may look like a maze, the market will come to terms with them, sooner than one would anticipate.

Be that as it may, one still has reservations about the MCLR approach per se, unless it is clarified that this is part of a larger game plan to evolve market-determined reference rates for lending in India (similar to the LIBOR benchmarked loans in overseas markets), preferably coinciding with the transition to Basel III, by March 31, 2019. The MCLR could well then be the chapter in a book, rather than the whole book. And here is why it should not be the whole book.

Monetary transmission is the major stated objective of the MCLR. It could be countered that both the Base Rate and the MCLR have anti-transmissive features, which go against the grain of what the RBI has been trying to achieve. Essentially, what it does is set a “floor” below which banks cannot lend under any circumstances, even though it would be commercially expedient do so. For an elucidation of this theme, please refer to ‘Why repo rate cuts cut little ice’ ( BusinessLine , May 5, 2013).

Transparency and fairness, two of the other justifications for the MCLR, can be achieved even without resorting to this norm.

Any prescriptive regime of lending rates would be antithetical to the free-play of market-determined rates, which has been the bedrock of the contemporary evolution of Indian banking. On liabilities, there has been a complete deregulation of rates, except on the balances in current accounts. It would be illogical to hem in lending rates, whatever the logic.

It would be naive to conclude that banks are not mature enough to determine for themselves at what rates they should lend, to whom, and for what tenor. As free-market advocate Milton Friedman said: “The most important single central fact about a free market is that no exchange takes place unless both parties benefit”.

In any case, there are enough regulatory ring fencings to ensure that banks do not trend towards the margins and stay, more or less, in the mainstream.

As we move towards Basel III, we should inherently believe in the Indian banking system’s ability to achieve adolescence. There is no other geography in the mature, developed economies, which have anything like the MCLR, even as a prescriptive regulatory norm. It would be anomalous to have Basel III and something like MCLR together.

It is micro-regulation, even at its best. As we encourage newer players to come into the market, the need is more for macro-prudential oversight rather than sitting in judgment on what rate each bank would lend for different tenors. As we evolve, we should let banks fend for themselves, rather than herd them.

There is no hard evidence to suggest that with the introduction of the Base Rate system from 2010, monetary transmission has been better. The MCLR is just a refinement of the Base Rate method, with incremental cost of borrowing being the added element.

And it is only those who have not read the Deepak Mohanty Committee’s report on Benchmark Prime Lending Rates of October, 2009, who would want MCLR lending in toto . The report itself recommended sub-Base Rate lending up to a defined percentage of incremental lending. It was a forward-looking document in that sense. So, why have the MCLR at all? There are some arguments in its favour.

There is need for guided banking at a time of turbulence, like the present, when any regulatory intervention should be welcomed. India’s regulatory architecture has been able to cope with trouble and tide over global crises.

Our central bank’s overall track record, over the past several years, starting from 1991, through the South East Asian crisis of 1997 (Bimal Jalan), the sub-prime crisis of 2008 (Y.V. Reddy/Subba Rao) and the currency crisis of 2013 (Raghuram Rajan) has been exemplary. Right now, from a certain perspective, we are, arguably, in a Goldilockian position, from where we can spring-board on to global economic leadership in, maybe, 15-20 years.

The factors in favour would be the subject matter for a separate discourse, altogether.

Even if one were to give the benefit of doubt, as it were, to the RBI, the MCLR ought to be welcomed. And in any case, the MCLR is an improvement over the Base Rate system. Any regulator who is part of an overarching governance structure, which looks set to deliver upwards of 7 per cent growth and manages to contain inflation on a glide path, ought to be trusted to get it right, 7/8 out of 10!

Upon assuming office as the RBI’s 23rd governor, Rajan said: “A central bank should never say ‘Never’!” He also quoted Rudyard Kipling from his poem If — “If you can trust yourself when all men doubt you, But make allowance for their doubting too” — setting a sagacity of approach, which deserves approbation. This was confirmation that his regulatory approach would be evolutionary. On balance, the MCLR would portend well for our times, if it were part of a plan and not “the” plan itself.

The writer is chief general manager with SBT. The views are personal

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