The need to regulate interest rates in a manner that the market
continues to function in an efficient way was felt decades ago.
Towards this objective, various measures have been proposed and
adopted. It can be safely stated that the regulations on interest
rate monitoring have been evolving and moving with time. A quick
recap of the key changes in this regime (especially for banks in
India) is as under:
1960 – Concept of minimum rate
of interest was introduced
1990 – Interest rates were
linked to size of loan
1994 – Minimum lending rates
was prescribed for loans < Rs 2 lakh. For loans > Rs 2 lakh,
these had to be linked to the Benchmark Prime Lending Rate
2000s – RBI identified that the
BPLR system fell short of its original objective and was not
bringing sufficient transparency to lending rates as banks could
lend below BPLR
2010 – Based on the
recommendations of the Working Group on BPLR, banks were advised to
switch over to the system of Base Rate.
This article looks at the evolution of the Base Rate Regime and
seeks to introduce readers to the newly introduced Marginal Cost of
Fund Based Lending Rate or as popularly called the MCLR regime.
BASE RATE REGIME
The Base Rate system replaced the BPLR system. It was introduced
with the objective of better transparency in lending rates of banks
on rupee loans.
The Base Rate is required to be determined by each bank and
shall include all those elements of lending rates that are common
across all categories of borrowers. There can be only one Base Rate
for each bank. Banks could choose any benchmark to arrive at the
Base Rate as long as it met the test of transparency.
To arrive at the Base Rate, Banks have the freedom to compute
cost of funds either on the basis of average cost of funds or on
marginal cost of funds or any other methodology. In order to
maintain transparency, the RBI made it mandatory for the banks to
reveal their Base Rate at all branches and also on their websites.
Changes in the Base Rate are also required to be conveyed to the
general public through appropriate channels.
RBI has recently introduced a new reference rate system for
rupee loans in the form of MCLR regime. Key features of the MCLR
MCLR replaces the Base Rate system of
From 1 April 2016, all scheduled
commercial banks have adopted the MCLR system for pricing their
It is a tenor linked benchmark. Banks
are therefore required to publish MCLR for the different maturities
i.e. ranging from overnight to one year maturities.
To get a quick sense, a comparative analysis is provided
Base Rate vis-a-vis MCLR
Rupee loan sanctioned
and credit limits renewed on or after 1st July 2010 but prior to
1st April 2016
Rupee Loan sanctioned
and credit limits renewed on or after 1st April 2016
Base Rate shall include
all those elements of lending rates that are common across all
categories of borrowers. RBI prescribes following illustrative list
of elements for computing base rate:
1. Cost of Deposits / Funds;
2. Negative carry on CRR and SLR;
3. Unallocatable overhead cost; and
4. Average Return on Net Worth.
MCLR computation shall
1. Marginal Cost of Funds;
2. Negative carry on account of CRR;
3. Operating costs; and
4. Tenor premium
Effect on tenor of
Base Rate does not
change with the tenor of loan
MCLR changes with the
tenor of loan
Frequency of review
Monthly. Till 31st March
2017, Banks which do not have adequate systems to carry out monthly
review, can so do on a quarterly basis.
FROM BASE RATE TO MCLR
As highlighted above, starting 1 April 2016, Banks have adopted
MCLR in relation to sanction of rupee loans / renewal of existing
credit limits. However, banks are required to continue with
reviewing and publishing Base Rate for the loans and credit limits
availed prior to 1 April 2016 till repayment / renewal of such loan
or credit limit.
Existing borrowers (for any borrowing prior to 1 April 2016)
have the right to opt to move to the MCLR linked loan.
Interesting time indeed!!
This article was first published in Banking
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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