RBI To Review How Banks Set Their Lending Rates

The RBI panel reviewing the MCLR-based rates will submit its report by September 24.

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RBI To Review How Banks Set Their Lending Rates

Banks revise their lending rates based on cost of incremental deposits.

Highlights

  1. A panel is reviewing the current MCLR-rate setting mechanism
  2. It was introduced last year for faster transmission of RBI rate cuts
  3. The panel will submit its report by September 24
The Reserve Bank of India (RBI) is reviewing the current MCLR or marginal cost of funds based lending rate lending rate system. "The experience with the MCLR-based lending rate system introduced in April 2016 for improving monetary transmission has not been entirely satisfactory," RBI deputy governor Viral Acharya said today, addressing the media after the central bank cut its repo rate by 25 basis points to 6 per cent, the lowest in nearly seven years.

Dr Acharya however said that the MCLR-based lending has been an improvement over the earlier base rate-based interest rate system. The RBI has set up an internal study group to explore whether the linking of bank lending rate could be made "direct to market-determined benchmarks," he added. 

The group will submit its report by September 24, 2017.

Dr Acharya also said that the RBI would be soon be releasing norms to deepen the corporate bond market which will also help improve monetary policy transmission.

Under the MCLR rate-setting method, banks calculate the benchmark lending rate by using the cost incurred on incremental deposits, not average cost of deposits. Banks have a reset period, which means that the interest will remain fixed for that period for the borrower and will be revised after that period. The bank will add a margin to MCLR to decide the actual rate of borrowing for a consumer. Banks review their MCLR every month.

Under the earlier base rate regime (for borrowers before April 2016), changes in lending rates happened slowly, making it difficult for lenders to transmit RBI's rate cuts. In the base rate mechanism, banks used to calculate their lending rates based on average cost of deposits.

Banks allow borrowers who are under the base-rate mechanism to switch to the MCLR regime for a fee.

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