Will the RBI move to link base rates with MCLR benefit customers?

I was a home loan borrower in the late 1990s and the home loan taken by me was on a ‘floating rate’ basis, which meant that the interest rate on my home loan would move up when interest rates go up and it would be revised downward when interest rates declined. This was fair enough, at least on paper. But I noticed that the bank from which I had borrowed revised the interest rate upwards immediately when the RBI announced hike in the interest rate, but when the RBI started announcing cut in interest rates, the bank was not as prompt and there was a time lag of a month or two while reducing the interest rate on my home loan. I fretted and fumed at this anti-borrower stance of the bank and foreclosed the 15-year loan within 10 years to save on my interest outgo.

The former RBI governor Raghuram Rajan seemed to have noticed this lop-sided policy of the banks and introduced the Marginal Cost of funds based Lending Rate (MCLR) in April 2016 to facilitate effective passing of the benefit of RBI’s policy rate cuts to the customers by the banks. Under the base rate and benchmark prime lending rate (BPLR) regimes, banks formulated their individual methodologies to determine the minimum rate at which they could lend, which resulted in slower passage of the benefits of rate cuts to their customers. The RBI expected that with the introduction of the MCLR system, banks would move the existing base rate credit exposures to the MCLR system, leading to a quicker and more transparent manner of transmission of policy rates. But this has not happened as the banks have a vested interest in persisting with the base rate lending regime.

To curb the bankers’ proclivity to delay the passage of benefits of RBI’s policy rate cuts to the customers, RBI has now asked the banks to link the base rate with the MCLR with effect from April 1, 2018. “Since MCLR is more sensitive to policy rate signals, it has been decided to harmonise the methodology of determining benchmark rates by linking the Base Rate to the MCLR with effect from April 1, 2018,” stated the RBI. But, as the RBI clarified, such linkage envisages ‘harmonising’ rather than equating the base rate with the MCLR.

It remains to be seen whether such ‘harmonising’ would be effective enough to prod banks to pass on any rate cut announced by the RBI after April 2018. But it must be noted that an internal RBI panel had suggested switching over to three external benchmarks, namely, T-bill rates, CD rates and RBI’s policy repo rate, in a time-bound manner so that better rates are available to the borrowers. This panel had observed that, “internal benchmarks such as the base rate and MCLR have not delivered effective transmission of monetary policy.”