Why the RBI is fussing over transmission & rigidity of base rate

While the RBI delivered the much-awaited cut in its policy repo rate, it came with riders. Banks received a rap on the knuckles for the unsatisfactory cuts in MCLR and rigidity in base rate, which the RBI proposes to scrutinise further.

The RBI has good reason to be disgruntled.

As has been highlighted time and again, the implementation of the MCLR regime last April has created a new set of issues.

The legacy issue being one. Old borrowers, who took loans prior to April 2016, continue to be charged interest on loans pegged to the base rate.

While banks have cut the MCLR sharply (by about one percentage point) they have only tinkered with the base rate, reducing it by just 10-30 basis points over the past year.

Hence, existing borrowers have not seen much relief in lending rates over the past year. It is the lack of transmission to this segment of borrowers (who currently account for chunk of the loans) that has irked the RBI, and rightly so.

Let us take the case of SBI. From 9.2 per cent in April last year, one-year MCLR has fallen to 8 per cent now. But the bank’s base rate has fallen only by 30 bps from 9.3 per cent to 9 per cent during this period.

While the RBI has enough reason to pull up banks on the base rate front, citing transmission issue with the MCLR may, at first glance, appear overdone going by data alone.

Between January 2015 and May 2017, the weighted average lending rates (WALR) on fresh loans (captures the incremental change in loan rates) have fallen by about 160 bps, as against the 175 bps cut in repo rate.

Given that only 50-60 per cent of banks’ funding gets re-priced, the transmission appears to have happened in its entirety (or even more).

But the sharp fall in lending rates was triggered by excess liquidity post demonetisation, rather than the MCLR structure. Under the MCLR, banks have to calculate the cost of funds based on the latest rates offered on deposits. This should ensure that changes in deposit rates are immediately reflected on banks’ cost of funds and hence, lending rates.

But the MCLR fell by just 25-30 basis points in 2016 as against the one percentage point fall in deposit rates. Much of the fall happened in January this year, when banks were flush with funds.

Over the past three to four months too, even as banks have continued to reduce rates substantially on fixed deposits, they have not tinkered much with their MCLRs.