The Reserve Bank of India has released it’s much anticipated revised guidelines for calculating benchmark lending rates. These guidelines will allow banks to calculate lending rates by basing them close to the market rates. This will help to transmit the monetary policy.
The new guidelines will be in effect from April 1, 2016. Here are some important points of the new guidelines.
HOW IT WORKS?
By the end of 2016, the RBI intends to move to the international benchmark rates. In the meantime, banks are given time to attain innovate and improvise their existing lending rates to comply with MLCR rates. So far, banks used to set lending rates according to the rate of outstanding deposits. The old system had given them the freedom to charge their desired rates. Banks are having a tough time switching to the new system. Due to this, the existing lending rate system may remain in place for a while.
MEETING THE CHALLENGE
Since most banks were having difficulty switching to the new standard, they’ve come up with a new strategy. Banks will publish different MLCRs of different maturity dates every month. Here, banks will reset dates on floating loans by specifying reset dates. This will allow clients to either link the loan or credit limit to the date of sanction or to the MLCR review date. The duration will either be one year or less.
ENTER THE MLCR
The new guidelines set by Reserve Bank of India are titled as Marginal Cost of Funds Based Lending Rates (MLCR). Since it is now in effect, all banks operating in India are liable to set their lending rates according to the MLCR. The MLCR will be determined by calculating the marginal cost, followed by lending, deposit and repo rates. Change in repo rate will also change other variables. Moreover, the actual rates of calculating the MLCR will include other components. For instance, the spread rate will allow banks to charge higher interest rates basing on the associated risk factor. This rate will be offered on all new deposits issued by banks. In turn, lending rates will reflect the market rates. As a result, many banks have cut down their deposit rates but these have not yet matched their lending rates. The idea is to streamline the benefits of both new and old customers. Though new customers will benefit from the new policy from the word go, old customers can avail it with some conditions. The RBI has given enough time to banks to make necessary arrangements to effectively accommodate MLCR. However, banks have not yet entirely switched over to the new regime.
WHY NEW REFORM
Several reasons forced RBI to formulate the MLCR reform. Firstly, banks were slow to respond to RBI’s repo rate. To acquire short-term funds, commercial banks rely heavily on RBI’s LAF repo. However, these banks are reluctant to change their individual lending rates. With the new reform in place, banks are liable to bring their lending and deposit rates at all costs.
EFFECTS ON MONETARY POLICY
In simple terms, the MLCR will pose a direct effect on the monetary policy of the country. By facilitating a so-called monetary transmission, it has enforced banks to calculate MLCR by including the repo rate. This will render the previous lending and deposit rates redundant to a good effect. The RBI considers the monetary transmission as the cornerstone of MLCR. Another way of viewing this policy is that it will help the state achieve desired economic and monetary objectives.
Overall, the MLCR based lending and deposit rates will help streamline all rates at one point. Essentially, it will serve as the umbrella under which the RBI will help and facilitate banks and consumers alike.