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Indian firms are approaching banks to switch their loans to lower interest rates as the loans come up for re-pricing following two repo rate hikes by the Reserve Bank of India (RBI).

These borrowers who are rated AA and above are looking to switch to marginal cost of funds based lending rate (MCLR) from the current external benchmark linked lending rate (EBLR) to avoid higher interest outgo.

As MCLR is linked to the banks’ cost of funds, corporates believe that the rate at which MCLR goes up will be slower as RBI hikes repo rate when compared to EBLR, which is linked to the treasury bill or the repo rate.

Over the last month, 364 day T-bill rate have gone up by around 150 basis points (bps) compared to MCLR, which has seen just a 30 bps increase. During the same period RBI has hiked repo rate by 90 bps and is expected to go up further by more than 100 bps. One basis point is 0.01%.

The one-year treasury bill is at 6.28% as of 22 June compared to 4.8% in April.

“Some of the corporates who have repo linked loans want to switch to MCLR. Sometimes MCLR works out cheaper. In a rising interest rate scenario, repo linked loans go up immediately, but MCLR doesn’t go up so fast. Banks might agree for a switch over at the time of re-pricing," said the head of a public sector bank.

Under loan pricing based on external benchmarks, any change in the policy rate is passed on to the lending rates for new and existing borrowers immediately. Banks are not allowed to adjust their spreads for existing borrowers for three years in the absence of any significant credit event. Borrowers have enjoyed the benefits of this loan pricing so far under a falling interest rate scenario, but are now staring at a steeper interest outgo as rates go up.

When policy rates were low and system was flush with liquidity over the last two years, banks were offering long term corporate loans at slightly below the then repo rate of 4%. This helped push up credit growth in the system and also allowed banks to quickly earn money by lending the excess funds to well rated corporates rather than parking it in a reverse repo window at 3.35%.

“Corporates feel that banks will not increase deposits by as much as 2% and, therefore, MCLR also will not go up to that extent as it is based on cost of funds," said an official with a private sector bank on condition of anonymity.

However, economists believe that MCLR and repo linked loans will converge even as the pace of increase will vary.

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