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 (BPLR)
- 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 system are:
- MCLR replaces the Base Rate system of lending rate
- From 1 April 2016, all scheduled commercial banks have adopted the MCLR system for pricing their rupee loans
- 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 below:
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 necessarily include:
1. Marginal Cost of Funds;
2. Negative carry on account of CRR;
3. Operating costs; and
4. Tenor premium
|Effect on tenor of loan
||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!!
Veena Sivaramakrishnan is equity partner designate and Saurabh Sharma is an associate at Juris Corp, a law firm adding value in foreign investments into India, banking & finance, joint ventures, M&A, private equity, dispute resolution and international arbitration, bankruptcy and restructuringNote: This article was first published in Banking Frontiers