New lending rate formula to make loans cheaper

1 Apr 2016 | By Achin Garg

Private and public sector banks are moving to implement a new lending rate structure, based on marginal cost of funds from 1st April 2016.

The move comes after the Reserve Bank of India had asked the banks to adopt Marginal Cost of Funds based Lending Rate (MCLR) to ensure better transmission of monetary policy.

This will lower the interest rate for loans.

In context: Making monetary policy transmission effective

MCLR What is MCLR?

Marginal cost based lending rate is an interest rate formula used by banks to set their interest rates for different loans.

Banks obtain funds for lending from deposits by customers and by borrowing from the RBI.

Under MCLR, banks will set interest rates on loans based on interest rates given for deposits and the repo rate (the rate at which bank borrows from RBI).

Banks not transmitting interest rate cuts

The RBI has reduced the interest rates by 1.25% during 2015; however, the banks have passed on only about 0.5-0.6% interest rate cuts to customers.
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17 Dec 2015Why are banks implementing MCLR?

Most banks currently use the average cost of funds to set their interest rates on loan products.

The present regime makes banks slow to respond to repo rate changes by RBI.

This affects the monetary policy transmission, the changes in interest rates by banks when RBI changes the repo rates.

To overcome this problem, RBI had asked the banks to adopt the MCLR system.

Ill effects of high interest rates

High interest rates make the loans costly and adversely impacts economic activity by making projects expensive. It ultimately dampens the growth rate of the economy. Hence, the industry advocates for lower interest rates.

1 Apr 2016New lending rate formula to make loans cheaper

1 Apr 2016MCLR to reduce interest rates

Various banks such as SBI, HDFC, Bank of Baroda, State Bank of Travancore, etc. have announced the adoption of marginal cost based lending rates.

According to Anshula Kant, Chief Financial Officer at SBI, home loans will get cheaper by 0.1% from present 9.55% to 9.45% with this change.

According to experts, lending rates will also come down by 0.1% for SMEs loans.