Lending rate guidelines to help policy transmission: ICRA

New MCLR, effective April 1, will impact the new borrowers immediately, while some old borrowers with better credit profile would want to shift to the new regime

Rating agency ICRA said the new methodology for calculating lending rates by banks will improve the efficiency of monetary policy transmission, but not fully so.

The Reserve Bank of India (RBI) on Thursday had said banks would have to calculate their lending rates based on marginal cost of funds, rather than average cost. Despite a cumulative 125 basis points cut in the policy rate this year, banks have so far only lowered their base rate by only 50-60 basis points.

According to ICRA, the new Marginal Cost of Funds-based Lending Rate (MCLR), effective April 1, will impact the new borrowers immediately, while some old borrowers with better credit profile would want to shift to the new regime, considering a falling interest rate scenario. The switch will in turn improve policy transmission. But, this will pose significant challenges to banks in the form of loan takeovers or switching the loans to the MCLR benchmark.

"Complete transmission would be linked to the extent of reduction in term deposit rates, as well as the proportion of term deposits in the overall funding profile of banks. For instance, if a reduction in banks' deposit rates matches the repo rate reduction and term deposits constitute 60 per cent of the funding, reduction in MCLR would be limited to 60 per cent of the repo rate cut," ICRA said.

However, with MCLR in place, banks will be able to offer short-tenure loans at competitive rates in line with rates prevailing in the commercial paper market, as the rate expected banks' short-tenure median MCLR to be lower than their current base rates by 80-90 bps.

"As on September 30, the banks' credit portfolio grew by a mere 8.8 per cent (year-on-year) while credit through bonds and commercial papers reported growth rates of 19 pre cent and 46 per cent, respectively," ICRA said.

Banks will be protected against a hit on their net interest margins, as the interest rate reset would be applicable only to new borrowings with immediate effect and to working capital borrowers with a lag.

In a declining interest rate scenario, and till the deposits contracted earlier mature, banks will be saved because of limited applicability of MCLR, introduction of tenor premium and flexibility to decide on reset date, ICRA said.