# MCLR and Base Rate.

What is going viral this April 1st?

Don’t think it to be a fool game. It’s real. SBI, the pioneer had taken initiation to announce the news of execution.

There is a press release on september 2015 by RBI w.r.t the banks interest rate calculation to improve transparency in the methodology followed by banks for determining interest rates on advances.

Till today (March 31st, 2016), the calculation is based on base rate system which includes the following factors

A) Cost of Deposits

B) Negative carry on CRR and SLR

D) Average Return on Networth.

The highest weightage is given to Cost of Deposits.

However, it was not mandatory that all the banks should have the same base rate. There were different methods that were followed.

The new concept is that banks HAVE to lend using rates linked to their funding costs. A bank raises money through deposits, bonds and wholesale borrowing. It has costs like salaries, rents, electricity costs etc. It also has to make a certain amount of profit at the very least. So the RBI has put all of this into a formula that banks can use to quantitatively determine how much their lending rate should be.

The new method MCLR(Marginal Cost of funds based Lending Rate) mentions a particular method to be followed. Following are the main components of MCLR.

A) Marginal cost of funds

B) Negative carry on account of CRR

C) Operating costs

Here, the highest weightage is given to the marginal costs.

Know the meaning of the above terms to understand why this method is powerful and transparent when compared to earlier methods, viz., base rate system and BPLR.

Negative carry on account of CRR is the cost that the banks have to incur while keeping reserves with the RBI. The RBI is not giving an interest for CRR held by the banks. The cost of such funds kept idle can be charged from loans given to the people.

Operating cost is the operating expenses incurred by the banks

Tenor premium denotes the higher interest that can be charged from long term loans.(means 1 year rate is higher than 6 month rate, etc)

Marginal Cost: The marginal cost is the novel eleme
nt of the MCLR. The marginal cost of funds will comprise of Marginal cost of borrowings and return on networth.  According to the RBI, the Marginal Cost should be charged on the basis of following factors:

1. Interest rate given for various types of deposits-  savings, current, term deposit, foreign currency deposit
2. Borrowings – Short term interest rate or the Repo rate etc., Long term rupee borrowing rate
3. Return on networth – in accordance with capital adequacy norms.

The marginal cost of borrowings shall have a weightage of 92% of Marginal Cost of Funds while return on networth will have the balance weightage of 8%.

According to the RBI guideline, “Banks will review and publish their MCLR of different maturities every month on a pre-announced date.” Such a monthly revision will compel the banks to consider the change in repo rate change if any made by the RBI during the month.

Inspite of severe emphasis laid by the RBI governor, Raghuram Rajan, to the banks to pass on interest rate cuts, less than half had been passed on to consumers this year. This made the necessity to invent this method.

Now with MCLR, banks are obliged to readjust interest rate monthly. This means that such quick revision will encourage them to consider the repo rate changes.

The final lending rate will be MCLR + Spread. (Earlier, Base Rate + Spread.)

While these guidelines will benefit new customers, existing customers will also have an option to shift to the new regime with some conditions.

SBI’S Announcement.

At SBI, the MCLR for loans upto one year maturity will be lower than its current base rate of 9.30% while those on two year and above maturity will be marginally above its base rate.

According to the statement on the bank’s website, the MCLR for overnight loans will be 8.95%, for one-month at 9.05% and for three-month at 9.10%.

The MCLR on 6-month loans will be 9.15% and for one year loans the rate would be 9.2%, the bank said.

Further the bank’s MCLR for two year loans would be at 9.3%. Loans with three year maturity would carry an MCLR of 9.35%, the bank said.