With the RBI issuing guidelines to calculate base rates using the marginal cost of funds, commercial banks are now left with lesser flexibility while fixing lending rates. All loans sanctioned after April 1 will be priced with reference to the marginal cost of funds-based lending rate (MCLR).
Rationale Banks are currently free to set their respective base rates (minimum lending rate) using either the average cost of funds or the marginal cost of funds, though very few of them use the latter metric.
The MCLR differs from the existing base rate in primarily two ways. One, of course, is the calculation of the cost of funds. Under the new method, the latest (at the time of review) rates offered on deposits or borrowings is taken into account.
The second is the tenor premium, which arises from loan commitments with longer tenors.
For instance, if a bank’s funding is only for three months and it lends for one year with a three months reset. Hence, banks do not carry any interest rate risk because after three months, it will raise deposits and whatever be the rate, it can pass on to borrowers. But banks will have a liquidity risk if it doesn’t get funding after three months. This is priced as tenor premium.
Benefit Earlier, banks were concerned that their margins would come under pressure if the MCLR were to become applicable across their entire loan book. But given that the RBI has made it applicable only for loans from April 2016, the impact will be lower. Secondly, today if thanks to easy liquidity, a bank is able to raise one-month deposits easily – at say 6.5 per cent – then it can lend at 8 per cent for one-three months.
This was not possible under the base rate system. The RBI has recognised that the benchmark rate has to have an associated tenor and hence allowed banks to have different MCLRs for various tenors.
While these are positives, issues can crop up after two or three years, when the entire loan book gets linked to MCLR. This is particularly true if a bank fails to get its asset-liability management right. In practice, banks run into liquidity issues mainly because of asset-liability mismatches. That is, their loans and deposits do not come up for payment at the same time.
In the new scheme of things, the challenge will be to create a portfolio of deposits with a balanced mix across tenors. This alone can help them be nimble-footed in reacting to interest rate changes and protect margins.