WEF 1st April 2016 Banks will move to new regime of MCLR which will replace Base Rate (BR) for all new loans. MCLR is brought with an objective to make the monetary transmission fast which is generally not taking place under present BR structure. Banks will have to set MCLR for five different tenors from overnight to one year and final lending rates will be decided in accordance with risk profile of different types of exposures.
The basic difference between BR and MCLR lies in components which are taken in to consideration while deciding the rates. The main components of BR are Cost of funds (Cost of Deposits), negative carry on CRR/SLR, Operating Expenses and minimum rate of return or profit. The negative carry on CRR/SLR and operating expenses will continue to be under new MCLR structure but the cost of funds will have a broader aspect like it will also include cost of borrowings which is directly linked to Repo Rate declared by RBI. The factor minimum rate of return or profit is explicitly excluded under MCLR but it will form a part of Cost of Funds in the name of return on net worth. Tenor premium which is added to base rate under existing structure depending upon tenor of the loan will be now included while calculating MCLR.
The MCLR will now be auto sensitive to Policy Rates declared by RBI and it will move as per actual rates prevailing in the market currently which was not happening under BR system.
Under Base Rate the banks were taking average cost of funds and not the current cost of funds which could not facilitate the transmission of rate changes by RBI and the objective of policy rates was not achieved. Whenever RBI makes downward changes in policy rates, it should be transmitted to monetary system but it was not happening under base rate system as the Banks used to calculate the Base Rate considering average cost of funds (interest given on deposits) during last one year. However under MCLR the marginal cost of funds approach is introduced which will include both marginal cost on borrowings i.e. current interest rates given on deposits and not the average rates given on deposits as well as marginal cost of borrowings (under Repo Window as per current repo rates), so as soon as repo rate undergoes changes there will be change in MCLR. MCLR will be driven largely by cost of deposits and repo rates.
In short the MCLR will move in tandem with current market rates i.e. current cost of raising deposits and borrowings under Repo unlike Base Rate which was not reflecting the prevailing market rates for raising funds. Now Banks will pass on both the rate cuts and rate hikes in to the system as per actual movement in market rates thereby ensuring tranparency.
MCLR will ensure availability of bank credit at a rate which is fair both to the borrowers and the Bank. It will also help borrowers reap the benefit of lower rates which will be passed on to borrowers through immediate downward changes in MCLR as soon as there is cut in Repo Rate by RBI. Similarly Bank will also be able to hike the rates as soon as there is hike in Repo Rate.
Banks will be publishing MCLR for five different tenor from overnight to one year and there will be interest rest clause in loan documents under which MCLR will be revised by next review or after one year of sanction which ever is earlier. Further Bank will review review and publish MCLR every month
The basic difference between BR and MCLR lies in components which are taken in to consideration while deciding the rates. The main components of BR are Cost of funds (Cost of Deposits), negative carry on CRR/SLR, Operating Expenses and minimum rate of return or profit. The negative carry on CRR/SLR and operating expenses will continue to be under new MCLR structure but the cost of funds will have a broader aspect like it will also include cost of borrowings which is directly linked to Repo Rate declared by RBI. The factor minimum rate of return or profit is explicitly excluded under MCLR but it will form a part of Cost of Funds in the name of return on net worth. Tenor premium which is added to base rate under existing structure depending upon tenor of the loan will be now included while calculating MCLR.
The MCLR will now be auto sensitive to Policy Rates declared by RBI and it will move as per actual rates prevailing in the market currently which was not happening under BR system.
Under Base Rate the banks were taking average cost of funds and not the current cost of funds which could not facilitate the transmission of rate changes by RBI and the objective of policy rates was not achieved. Whenever RBI makes downward changes in policy rates, it should be transmitted to monetary system but it was not happening under base rate system as the Banks used to calculate the Base Rate considering average cost of funds (interest given on deposits) during last one year. However under MCLR the marginal cost of funds approach is introduced which will include both marginal cost on borrowings i.e. current interest rates given on deposits and not the average rates given on deposits as well as marginal cost of borrowings (under Repo Window as per current repo rates), so as soon as repo rate undergoes changes there will be change in MCLR. MCLR will be driven largely by cost of deposits and repo rates.
In short the MCLR will move in tandem with current market rates i.e. current cost of raising deposits and borrowings under Repo unlike Base Rate which was not reflecting the prevailing market rates for raising funds. Now Banks will pass on both the rate cuts and rate hikes in to the system as per actual movement in market rates thereby ensuring tranparency.
MCLR will ensure availability of bank credit at a rate which is fair both to the borrowers and the Bank. It will also help borrowers reap the benefit of lower rates which will be passed on to borrowers through immediate downward changes in MCLR as soon as there is cut in Repo Rate by RBI. Similarly Bank will also be able to hike the rates as soon as there is hike in Repo Rate.
Banks will be publishing MCLR for five different tenor from overnight to one year and there will be interest rest clause in loan documents under which MCLR will be revised by next review or after one year of sanction which ever is earlier. Further Bank will review review and publish MCLR every month
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