What is Marginal Cost of funds based Lending Rate? How is this different from the previous Base Rate system? Discuss the impact of decline in MCLR on economy?
MCLR describes the method by which the minimum interest rate for loans is determined by a bank - on the basis of marginal cost or the additional or incremental cost of arranging one more rupee to the prospective borrower.
The MCLR methodology for fixing interest rates for advances was introduced by the Reserve Bank of India with effect from April 1, 2016. This new methodology replaced the base rate system introduced in July 2010.
The marginal cost of funds based lending rate (MCLR) refers to the minimum interest rate of a bank below which it cannot lend, except in some cases allowed by the RBI. It is an internal benchmark or reference rate for the bank. Based upon this MCLR, interest rate for different types of customers should be fixed in accordance with their riskiness.
This benchmark is based on:
Marginal cost of funds
Negative carry on account of Cash Reserve Ratio (CRR)
The MCLR applicable from 1 April, 2016 have to be revised monthly by considering some new factors including the Repo rate and other borrowing rates.
Earlier base rate was used which was calculated based on:
Cost of Deposits/funds
Negative Carry on CRR and SLR
Unallocatable Overhead Cost
Average Return on Net Worth
Impact of decline in MCLR on economy:
As MCLR is the benchmark lending rate its decline will reduce the cost of borrowing from banks. This will increase the credit growth rate and investment in the economy.
As in recent various industry bodies has said that high cost of funds in a week global economic scenario prevents them from investment.
Low cost funding will also make Indian products more competitive in global market and boost exports.
With increased investment more employment opportunities will emerge.
Prior to introduction of MCLR the transmission of monetary policy rates to borrowers was not efficient and quick, as a result new methodology was introduced. Simultaneous to introduction of new methodology interest rates on small savings instruments were reduced to facilitate low cost deposits for banks which will reduce the cost of borrowing and lending. In recent because of demonetization banks have received huge amount of funds, this may lead them to reduce MCLR and that will boost economic activity.
Despite these changes the high NPAs and low savings rate also hurt the chances of reduction in MCLR. Along with this rising oil prices globally and any sudden spurt in inflation willalso affect borrowers immediately, as MCLR will force banks to change their benchmark lending rates quickly.
As a result of this MCLR can act as a double edged sword which allows accommodative monetary policy rates to be transmitted to borrowers immediately and also forcing banks to act with alacrity to increase their lending rates in case of inflation.