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RBI annual report lists review of MCLR in agenda for current fiscal
August, 31st 2018

RBI has put the spotlight back on the shortfalls of the Marginal Cost of Funds Based Lending Rate (MCLR) system.

The Reserve Bank of India released its 2017-18 annual report yesterday, which has put the spotlight back on the shortfalls of the Marginal Cost of Funds Based Lending Rate (MCLR) system. "In order to improve transparency in lending rates, the MCLR system was introduced in April 2016 in place of the then prevailing base rate system. However, transmission during the MCLR regime has not been entirely satisfactory," read the report.

So in its agenda for 2018-19, the apex bank has listed reviewing the MCLR guidelines. "For the purpose of fostering competition and re-orienting the banking structure in India, the policy on subsidiarisation of foreign banks and the Marginal Cost of Funds Based Lending Rate (MCLR) guidelines will be reviewed," it added, without divulging more details.

To remind you, back in October, an internal RBI study group had suggested that banks should switchover to a new interest rate calculation regime from the existing MCLR system for effective transmission of policy rate to borrowers. It had recommended moving to one of the three external benchmarks - the treasury bill rate, the certificate of deposit (CD) rate and the RBI's policy repo rate, which is outside the control of an individual bank, from April 1, 2018.

However, the addendum released by the RBI in February this year, covering feedback received from stakeholders on the study group's report, made it clear that the Indian Banks Association wanted the MCLR system to continue. "While an internal benchmark such as MCLR (or any other equivalent based on deposit funding cost) seems attractive from the standpoint of banks, it suffers from a fundamental flaw in that it makes banks insensitive to policy rate changes. Put simply, banks face no urgency to adjust their deposit rates in response to policy rate changes. And as long as banks do not change deposit interest rates, that would continue to stifle transmission to their lending rates," the apex bank had noted.

Furthermore, the addendum had pointed out that quite a sizable loan portfolio of banks continued at the base rate and some loan portfolio at the BPLR after over "21 months of introduction of the MCLR system". That has now been addressed. Since April 2018, the RBI directed banks to harmonise all old loans linked to the base rate to MCLR. Meanwhile, the apex bank is still mulling over the study group's recommendations.

And bankers seem to be coming round to the fact that a review is imminent. "World over, the bank rates have moved to an external benchmark which leads to uniform pricing. Currently, banks in India calculate based on their internal benchmark which can be disputed and leads to a difference in rates between banks. This is likely to be changed," PK Gupta, managing director at SBI, told The Economic Times.

Also up for a review in the current fiscal is the policy seeking subsidiarisation of foreign banks operating in India, around seven years after the RBI first proposed the idea in a discussion paper in January 2011. Although the apex bank had hoped to lure foreign banks to open local subsidiaries in exchange for more branches, only Singapore's DBS and State Bank of Mauritius (SBM) have so far applied to open local units. Bigger foreign banks such as Citibank, HSBC, Standard Chartered and Deutsche Bank have shied away from opening subsidiaries.

Abizer Diwanji, partner, financial services, EY, told the daily that digitisation has made bank branches insignificant and, hence, "large foreign banks do not see the advantage of opening a local unit" in the country. "One needs greater clarity on the review RBI is planning but the situation on the ground has not changed since the last few years," he added.



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