Base rate to be linked with MCLR
What is the issue ?
- The Reserve Bank will link the base rate for loans given by banks to the MCLR starting April 1, 2018 i.e. from the new financial year.
Why this move ?
- Reserve Bank of India (RBI) expressed concern that a large portion of bank loans remain linked to the base rate despite the introduction of the MCLR in April 2016.
What does this mean ?
- Linking of base rate to marginal cost of funds-based lending rate (MCLR) will likely reduce the gap between base rate and MCLR.
- As of 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.
Why is MCLR considered to be more sensitive to monetary policy transmission ?
- 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.
- The most important difference is the careful calculation of Marginal costs under MCLR. On the other hand under base rate, the cost is calculated on an average basis by simply averaging the interest rate incurred for deposits. The requirement that MCLR should be revised monthly makes the MCLR very dynamic compared to the base rate.
What is base rate ?
- It is the lending rate of banks below which the banks are not allowed to lend.
- Base rate was used for deciding the interest rate for loans before the introduction of MCLR rate.
About base rate :
- Considered slow in responding to monetary policy transmission.
- An increase in repo rate (by RBI) is reflected very slowly in the lending rates and deposit rates fixed by banks whereas an increase in the repo rate is reflected very quickly.
- Quarterly revision of base rate.
Components of base rate :
- Cost for the funds (interest rate given for deposits),
- Operating expenses,
- Minimum rate of return (profit), and
- Cost for the CRR (for the four percent CRR, the RBI is not giving any interest to the banks)
What is Marginal cost of funds-based lending rates (MCLR) ?
- 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.
Components of MCLR :
- Marginal cost of funds;
- Negative carry on account of CRR;
- Operating costs;
- Tenor premium.