Shift to MCLR regime helps banks pass on rate cuts

Further softening of interest rates linked to deposit rate cuts, credit uptick

Banks are passing on the rate benefit to customers as they shift from base rate anchor to marginal cost of funds-based lending rate (MCLR) — the new loan pricing regime. However, any further reduction in lending rates would hinge on the softening of deposit rates and improvement in offtake.

MCLR was introduced in April 2016. This system was designed keeping in mind the account limitations of the benchmark prime lending rate (BPLR) and base rate regimes.

According to public-sector bank executives, the process of migrating existing base rate-linked loans to MCLR is underway. This will help banks reduce the net effective rate for customers. MCLR rates have softened due to drop in deposit costs. Going forward, the benefit arising out of shifting from base rate to MCLR regime could be in the region of 15-20 basis points (bps).

The Reserve Bank of India (RBI)’s contention has been that it has reduced policy rates by 175 bps since fourth quarter of 2014-15 but banks have not passed on the benefit in the same proportion.

Banks have been reviewing rates each month under the MCLR regime since April. Much of revision has been downward, with the quantum being 5-10 bps.

The MCLR regime is quite transparent for calculating benchmark rates. The credit costs and amounts to be set aside as provision for bad loans are high, while the loan offtake is tepid. Till the situation improves, banks have very little room to bring down lending rates. It is tough to say how much rates would come down, a senior Bank of India executive pointed out.

G Yadwadkar, deputy managing director of IDBI Bank, said the effective interest rate for existing clients would come down as they are moving from base rate to MCLR. Any further room for a cut in MCLR may be limited till further softening in the deposit rates happen.

A State Bank of India official said benefits from the Seventh Pay Commission have begun to put money in the hands of government employees. And, part of it would come to banks as deposits. The government has also cut the small savings deposit rates by 10 bps. This would give room to reduce deposit rates and cost of funds, and revision in lending rates would follow.

Banks would need six more months to adjust with the MCLR system, which would complete one year by March 2016. After this, there would be more scope for transmission, said the SBI executive cited above. According to an RBI analysis, during April-September 2016, the median one-year MCLR of public-sector and private-sector banks declined 15 bps and 25 bps, respectively.

Banks have, however, increased the spread and term premia over the same period, effectively leaving the weighted average lending rate (WALR) on outstanding rupee loans unchanged.