MCLR or Marginal Cost of Funds Lending Rate is good for borrowers as banks have to pass on lower cost of funds when interest rates fall in the economy to the borrower. However banks that are efficient may not be able to earn higher spreads given the one rule applicable for all.
Indian banks are a beleaguered lot. The former RBI Governor Dr Raghuram Rajan had turned on screws on them for recognition and resolution of Non Performing Assets. As a result, quarter after quarter they declared lower profits and higher provisions. Banks were saddled with low credit growth and competition from nimbler Non Banking Finance Companies and Housing Finance Companies.
Just as things were looking up, banks got hit by demonetisation. Banks had to bear the brunt of the execution of currency exchange, recalibration cost of the ATM’s and the cost of logistics of moving cash all over the country. To add to it most of the deposits, which they got from the public got impounded by the RBI in the form of Cash Reserve Ratio for a fortnight.
On 1 Jan 2017, State Bank of India, the big daddy of Indian banks lowered the lending rate as defined by MCLR by 90 bps .. Many other banks followed suit. This means that their revenues from interest income would be lower till the next reset.
This is good news for borrowers though as their interest cost will be lower.
What is MCLR- Marginal Cost of funds Based Lending Rate?
This is a new guideline which banks had to follow from April 2016 onwards, which define their revenue from lending. The main concept is that banks have to set a lending rate which has some connection to the deposit rate. It is more dynamic rate then the earlier used base rate.
MCLR is more transparent and also very effective for monetary transmission. It is formula based, so banks have no choice but to reset their lending rate based on changing interest rate environment.
How is MCLR calculated?
For banks the cost for obtaining funds is basically the interest rate given to the depositors. The MCLR norm is a formula which includes different components of marginal costs of funds for the bank. A new factor is the inclusion of interest rate given to the RBI for getting short term funds – the repo rate in the calculation of lending rate.
Following are the main components of MCLR.
- Marginal cost of funds
- Negative carry on account of CRR
- Operating cost
- Tenor premium
The marginal cost of borrowing shall have a weightage of 92% of Marginal Cost of Funds while return on net worth will have the balance weightage of 8%.
According to the RBI, the Marginal Cost of funds should be charged on the basis of following factors
A) Interest rate given for various types of deposits- savings, current, term deposit, foreign currency deposit.
B) Borrowings – Short term interest rate or the Repo rate etc,Long term rupee borrowing rate.
C) Return on net worth – in accordance with capital adequacy norms.
Negative carry on account of CRR: is the cost that the banks have to incur while keeping reserves with the RBI. The RBI does not give interest for CRR held by the banks. The cost of such funds kept idle can be charged from loans given to borrowers according to the formula of MCLR. (Cash Reserve Ratio is the % of deposits which the bank has to keep with the RBI at no cost, which at present is 4%)
Operating cost: is the operating expenses incurred by the banks
Tenor premium: denotes that higher interest that can be charged for long term loans
Accordingly MCLR formulae is, if one year fixed deposit rate of bank is 7%, then the MCLR will be 7 %+CRR Cost + Operation cost+ tenor premium.
The Reserve Bank of India (RBI) has asked banks to set at least five MCLR rates—overnight, one month, three month, six month and one year. Besides these, banks are free to set rates for longer durations as well. The rates have to be reviewed on a monthly basis,
MCLR-linked loans would be reset for a maximum of one year. So, you will have a new interest rate on your home loan at a pre-decided time and for a maximum period of one year
State bank of India changed its one-year MCLR to 8 per cent as compared with 8.9 per cent earlier. Home and auto loans of most banks are linked to their respective one-year MCLRs.
The rate cut would be applicable to all fresh loans. The effective interest rate for new home loans got reset between 8.6-9.1% for SBI. Existing loans linked to the MCLR will be repriced when it comes up for reset.
A home loan based on MCLR system provides retail customers with a more dynamic interest rate environment and can be beneficial to them.When a home loan is taken linked to MCLR, it has to be kept in mind that the interest rate changes only on a pre-determined reset date. Between two reset dates, an MCLR home loan works like a fixed rate loan oblivious to any changes in the MCLR. RBI allows banks to have a reset period up to a maximum of one year.
This is great option for borrowers when interest rates are on a decline.
However for the banks who were a bit tardy in passing on lower interest rates to their borrowers this may shave off a bit from their margins.