MCLR: Banks flag hurdles for review

After operating a marginal cost-based lending rate (MCLR) system from April, banks have flagged, for a review, issues such as volatility in rates due to frequent (monthly) reviews, fine-tuning of term premiums and static elements in the formula.

Also the small downward movement of interest rates on deposits is, to some degree, limiting the spread of the desired effect (reduced loan rates), said bankers.

Reserve Bank governor Raghuram Rajan told the media on Tuesday, after the latest policy review, that they'd soon review how MCLR had worked.

Bankers say the cost of funds has come down by 50-60 basis points from the earlier base rates; however, transmission to end-consumers hasn’t been more than 20-30 bps. Banks can add a spread component over and above the MCLR, depending on a customer’s risk profile, limiting the transmission.

The chief financial officer (CFO) of a private bank said: “The biggest problem the banking system is facing on MCLR is that deposit rates haven’t been able to come down meaningfully. These are in low single digits for most banks and if they cut further at this time, the growth rate in deposits will slip further. That is probably why the desired effect of MCLR has not been achieved.”  

Another challenge, say bankers, is the volatility from the monthly change in MCLR. Banks have to change it in each quarter and move to a monthly review from the next financial year but most are already doing the latter.

“It is fluctuating a lot and that in turn is having an impact on the overall total operational cost and other things. This volatility can be a result of various factors, including divergence in advances and deposit rates, which cannot be controlled,” said the CFO quoted earlier.

An executive director with a large public sector bank said fine-tuning of term premiums along the yield curve was required. Banks are learning to make amends, based on experience under the new regime. It would evolve gradually.

Another problem the lenders face is that some of the factors in calculating the MCLR rates are static. "Some components do not change, like the interest rate on savings and current accounts. There are similar such issues in the calculations which probably can be ironed out better,” said the treasury head of a private bank.