Bank customers in India continue to pay for the systemic inefficiencies in monetary policy transmissions.
In this context, RBI’s push for the comprehensive embrace of MCLR regime is a positive despite the reluctance of banking majors.
What are some of RBI’s actions to enhance Monetary Transmission?
“Monetary Transmission” is a qualitative measure of the impact of central bank’s policy decisions on the banking system and the larger economy.
Currently, India fares low on the effectiveness of monetary transmission as RBI’s policy directives aren’t being reflected sufficiently in bank interest rates.
To improve the transmission efficiency, the central bank introduced the “Marginal Cost of funds-based Lending Rate” (MCLR) regime in 2016.
MCLR is a cost plus module, where banks choose a “fixed percentage margin” over and above whatever the RBI mandated bank rate is.
This replaced the “Base Rate” regime which was in place since 2010, in which banks were free to fix any interest rate above RBI’s bank rate.
In this context, recently, RBI has said that it would instruct banks to switch pre-existing ‘base rate customers’ also to the new MCLR regime by April 2018.
But the stated intent hasn’t been effectuated yet, primarily due to the reluctance of banks that stand to lose revenue.
Notably, even now, base rate customers can shift to the MCLR regime but it is only after paying a fee, which is proving a deterrent.
What would’ve been the likely impact of RBI’s latest MCLR push?
The latest move was supposed to push banks to lower lending rates, which currently under the base rate system is considerably higher.
Notably, State Bank of India’s lending under the base rate system is about 8.7%, whereas the one-year MCLR rate is just about 8.25%.
This difference of 45 basis points could make a significant difference in borrowing costs, especially for smaller firms and retail consumers.
Significantly, it is to be noted that a large proportion of outstanding loans and advances continue to be linked to the base rate system.
What is the way ahead?
The RBI has been facing flak from multiple quarters for ineffective monetary administration, which is affecting the larger economy.
From a consumer perspective too, an unfair situation has emerged as new borrowers get lower MCLR interest rates while older ones continue on the higher Base rates.
Banks are reluctant as they are already saddle with immense pressure due to record losses and mounting levels of Non-performing Assets (NPAs).
An RBI study estimates that public sector banks could take a Rs. 40,000-crore hit on revenue if they allow all base rate borrowers to switch to the MCLR rate.
Nonetheless, given the need to revive the economy through consumption and fresh investment, monetary transmission needs to become effective.
Hence, the push for MCLR is inevitable and needs to be implemented.
