Relevance: GS-3: Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.

Key Phrases: Reserve Bank of India, State Bank of India, MCLR, repo rate, Operating costs, Tenor premium, monetary policy committee, external benchmark-linked lending rate, accommodative policy, rate hike.

Why in News?

• Loans to be costlier as banks hike rates; SBI, Axis revise MCLR upwards.

Context:

• State Bank of India (SBI), the country’s largest lender, and some of the other large banks have started increasing their benchmark lending rate — the marginal cost of funds-based lending rate (MCLR) — a move that will make customers pay more on their housing, auto, and other retail loans.
• SBI increased its MCLR by 10 basis points, with effect from April 15, across all tenors (100 bps = 1 percentage point).
• The one-year MCLR has been revised to 7.1 per cent while two- and three-year MCLRs have been raised to 7.3 per cent and 7.4 per cent, respectively. The MCLR is a benchmark interest rate, which is the minimum rate at which banks are allowed to lend. Most loans are linked to the one-year MCLR.

What is MCLR?

• Introduced by the RBI in 2016, MCLR or marginal cost of funds-based lending rate 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.
• Components of MCLR are:
  • Base Repo Rate,
  • Operating Costs,
  • Current cost of carry-in cash reserve ratio and
  • Tenor premium
• It 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.

Difference Between MCLR And Base Rate

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.
• 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?

• According to analysts, borrowers could either increase the tenure of the loan to reduce the EMI or make part pre-payment of such loans to bring down the EMI.
• Typically in a rising rate environment, lenders keep the EMI unchanged and increase the loan tenure to account for higher interest burden. However, in the case of home loans, where increase in tenure may not be possible, the lenders will have to increase the EMIs also, which will increase the debt servicing burden for the borrowers.

Way Forward:

• 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.

Source: The Hindu BL

Mains Question:

Q. What do you understand by marginal cost of funds-based lending rate? How does it affect the lending to the borrower? Examine.