In the absence of a sunset clause for the base rate regime, banks have not been proactive in moving old borrowers from the base rate to the MCLR. Why? Because, lending rates under the MCLR have been 80-90 basis points lower than the base rate through most of last year.
In a bid to remove this disparity and offer some respite to old borrowers under the base rate regime, the RBI has finally decided to link the base rate to the MCLR with effect from April 2018.
But given that rates are already on the way up, it is a measure that has come in too late for borrowers to rejoice. On the contrary, a higher spread and faster pace of increase in lending rates could hurt them more.
Legacy issues
Under the base rate regime, banks mostly used the average cost of funds method. Hence, the bulk of their deposits were unaffected by rate changes. This limited the cut in lending rates.
Under the MCLR, banks calculate their cost of funds based on the latest rates offered on deposits. But the difference in their computation still does not explain the one percentage point difference between the two benchmark rates, nearly two years after the MCLR was introduced.
The RBI’s move to link the base rate to the MCLR, on the face of it, appears a sound solution, but there are still several weak links to it.
For one, while the modalities of how the linking will be done is awaited, there is no denying that old borrowers have missed the bus on rate cuts. They will now have to deal with a faster pace of rise in lending rates, riding on the more nimble MCLR structure.
Two, banks charge a spread over benchmark lending rates — either base rate or MCLR — to arrive at the effective lending rates. In the past and even under the MCLR, banks charge the spread arbitrarily and use it as a balancing figure to derive the desired lending rate.
Hence, old borrowers, will need to watch out for the spread that banks charge them over and above the new benchmark rate, after linking the base rate to MCLR.