RBI to link base rate with MCLR from 1 April

MCLR is calculated on the basis of incremental cost of funds, making it a more reliable benchmark rate as compared to the base rate, usually calculated by taking into account average cost of funds. Photo: Aniruddha Chowdhury/Mint

Mumbai: The Reserve Bank of India (RBI) on Wednesday said it will link the base rate for loans with the marginal cost of funds-based lending rate (MCLR) from 1 April to improve monetary policy transmission.

This is likely to narrow the gap between the base rate and MCLR, and benefit borrowers who are still using the base rate, said some analysts.

However, with details of the methodology due only next week, others saw it as just a phasing out of the base rate system. Speaking at the post-monetary policy press conference, RBI deputy governor N.S. Vishwanathan clarified that the two rates would be “harmonized and not equalized”.

The central bank expressed concern that a large portion of bank loans remain linked to the base rate despite the introduction of the MCLR in April 2016. Weak monetary transmission during a rate cut cycle has been one of the central bank’s pet peeves.

The MCLR is more sensitive to monetary policy transmission and is closely linked to the actual deposit rates. MCLR is calculated on the basis of incremental cost of funds, making it a more reliable benchmark rate as compared to the base rate, usually calculated by taking into account average cost of funds. For instance, since April 2016, while the repo rate has been reduced by 75 basis points, State Bank of India’s base rate has come down by 65 basis points but the one-year MCLR by as much as 1.25 percentage points. One basis point is one-hundredth of a percentage point.

“We have been mentioning in the earlier policies that we are concerned about the inadequacy of monetary transmission to the base rate and about a large number of accounts under the base rate regimen,” said Vishwanathan.

“We are now harmonizing the calculation of base rate with MCLR so that the responsiveness of the credit portfolio to monetary policy signals is not hindered by interest rate on a large part of banks’ loan portfolios being linked to base rate.” According to Pritesh Bumb, banking analyst at Prabhudas Lilladher Pvt. Ltd, currently 60-70% floating rate loans have been moved to MCLR and the rest remain linked to the base rate.

“Borrowers still under the base rate regime may benefit from this harmonization as currently MCLR is lower than base rate,” said Udit Kariwala, senior analyst, financial institutions, at India Ratings.

Dinabandhu Mohapatra, managing director and chief executive at Bank of India, said that the harmonization of the rates is likely to narrow the gap between MCLR and base rate.

“There is a lot of gap between the MCLR and the base rate and the statement from RBI today indicated that the gap will be reduced with base rate calculations being in sync with MCLR calculations. As most banks have migrated a majority of the accounts to MCLR, the impact of the move will not be very high,” Mohapatra added.

It, however, remains to be seen if the calculations merely improve rate transmission or reduce the gap between the two rates as well.

“Right now the base for fixing base rate and MCLR is different. It is likely that the components of calculating the two will be aligned. Also, MCLR is reviewed on a monthly basis and base rate on a quarterly basis. With the harmonization of the two, it is likely that base rate will be reviewed on a monthly basis as well. It is unlikely that there will be a negative impact on profitability,” P.K. Gupta, managing director of State Bank of India said. Others believe that the base rate will be phased out.

“It appears that this is some sort of sunset clause for base rate in as much as all benchmark rates will be linked to MCLR... However we will await final instructions from RBI,” said V.G. Kannan, CEO, Indian Banks’ Association.

Vivina Vishwanthan and Gopika Gopakumar contributed to this story.