Previous Year Question
What is/are the purpose/purposes of the ‘Marginal Cost of Funds based Lending Rate’ announced by the RBI?
These guidelines help to improve transparency in the methodology followed by banks for determining the interest rates on advances.
These guidelines help to ensure availability of bank credit at interest rates which are fair to the borrowers as well as the banks.
Select the correct answer using the code given below:
1 only
2 only
Both 1 and 2
Neither 1 nor 2
Correct Answer: C
Detailed Solution
The RBI introduced the Marginal Cost of Funds Based Lending Rate, or MCLR, with effect from 1 April 2016. It replaced the earlier Base Rate system for new rupee-denominated loans.
MCLR is the internal benchmark lending rate below which a bank ordinarily cannot lend, except for certain categories permitted by the RBI.
Statement 1 is correct.
Before MCLR, there was inadequate uniformity in the costs and methodology used by different banks for determining their base lending rates. This could make the transmission of policy-rate changes to bank lending rates weak and unclear.
The RBI specified the principal components for calculating MCLR:
marginal cost of funds;
negative carry resulting from maintaining CRR;
operating costs; and
tenor premium associated with the period of a loan.
The marginal cost of funds reflects the current cost incurred by a bank on new deposits and other borrowings. Changes in the Repo Rate and market interest rates may therefore influence the bank’s cost of new funds and its MCLR.
Banks are required to publish MCLRs for different tenors, such as overnight, one month, three months, six months and one year. This makes the lending-rate methodology more transparent and comparable.
Statement 2 is correct.
MCLR was also intended to ensure that banks determine reasonable lending rates after considering their actual cost of funds and the credit risk involved.
An excessively low lending rate can affect a bank’s financial condition and the interests of depositors, whereas an unnecessarily high rate makes credit expensive for borrowers. The MCLR framework seeks to balance the interests of both parties.
The final lending rate may ordinarily be expressed as:
Lending rate = MCLR + Spread
The spread may reflect the borrower’s credit risk, the nature of the loan and other permitted business-related factors.
MCLR also sought to make bank lending rates more responsive to changes in policy and market interest rates. Hence, both statements are correct.