What is Marginal Cost of funds-based lending rate (MCLR)?
Introduced by the RBI in 2016, MCLR was aimed at ensuring faster transmission of repo rate changes.
It was designed to be a transparent rate transmission mechanism as against its predecessor — the benchmark prime lending rate or BPLR.
Apart from the base repo rate, operating costs, current cost of carry-in cash reserve ratio and tenor premium are components of MCLR.
MCLR proved to be effective compared to BPLR as the former factored the current cost of money, whereas BPLR was based on average cost. This ensured better transmission.
Why are banks increasing MCLR?
After three years, SBI increased its MCLR by 10 basis points (bps), while Bank of Baroda, Axis Bank, and Kotak Mahindra Bank raised their MCLRs by 5 bps each across tenures.
This follows the RBI’s monetary policy committee or MPC replacing the reverse repo with SDF or the standing deposit facility as the floor rate for liquidity adjustment facility.
SDF allows the RBI to absorb liquidity (deposit) from commercial banks without giving government securities in return to the banks.
Under reverse repo (which is a part of the Liquidity Adjustment Facility), banks will get government securities in return when they give excess cash to the RBI.
As a standing facility, the SDF supplements Marginal Standing Facility or the MSF (SDF for liquidity absorption whereas MSF for liquidity injection).
In effect, it incentivises banks to park more money with the RBI as SDF can earn 3.75 per cent interest as against the reverse repo at 3.35 per cent.
SDF can have an indirect implication as banks may raise their deposit rates to attract more money into the system. As a precursor, they are tinkering with the lending rate so that the impact on banks’ profitability can be minimised.
What does it mean for borrowers?
Borrowers are subjected to two categories of benchmark rates – MCLR and EBLR or external benchmark lending rate.
Introduced in 2019, EBLR was intended to plug the deficiencies in MCLR, which faced the criticism of slower than expected rate transmission.
Therefore, to further increase transparency and transmission, EBLR, which allowed banks to directly benchmark their loans against the repo rate, was introduced.
However, EBLR is now widely used in home loans. Just recently, banks have started adopting EBLR for other retail products such as personal loans and education loans, which were earlier based on MCLR.
However, being short-tenured, the recent hikes may not have much impact on retail loans.
That said, over 60 per cent of corporates borrow based on MCLR. Only fresh borrowing since mid-2020 and roll over of loans to high-rated corporates are happening at EBLR. Hence, corporates may bear the brunt of a MCLR hike.
Are the banks going against the trend by increasing MCLR when RBI has kept the Bank Rate static and Monetary Policy accommodative?
Yes and no.
As mentioned above, the hike in SDR indirectly is a rate hike by 40 bps as it allows banks to earn more income from deposits.
It’s a tactical tool to reduce the money supply in the market and hence to that extent banks are justified in increasing the MCLR to account and create a buffer for a possible increase in their deposit rates as well.
However, at a time when Indian industries aren’t geared to bear higher cost of leverage, the rate hike goes against the spirit of the MPC’s accommodative stance.
While one could say that the RBI Governor’s speech clearly signalled a tapering of easy money and a gradual increase in repo rates, sections of India Inc feel banks could have deferred the MCLR hikes by at least a quarter, to give companies a breather to plan for these rate hikes.
Does this mean that a Bank Rate increase will happen soon?
The RBI Governor set the base for a gradual and calibrated withdrawal of excess liquidity in a non-disruptive manner earlier this month.
Seen along with the policy action of central banks globally, it does make a case for a rate hike in India.
Until recently, excess liquidity in the system was tapered or partially withdrawn using indirect or non-monetary tools such as VRRR (variable rate reverse repo auctions) and forex auctions.
But these don’t help fight inflation, a battle which has now become necessary to take on, given that the recent wholesale inflation number at 14.55 per cent is at an all-time high.
Therefore, a repo rate hike is the last ammunition that the central bank will unleash to serve the dual purpose of shirking liquidity and controlling inflation. Economists expect 50 basis points increase in repo rate by December 2022.
