Public Sector Banks Reduce MCLR to Improve Monetary Transmission
Source:Indian Express ↗
Why It Matters
Interest rate transmission is a core concept in the RBI's monetary policy toolkit. The UPSC frequently evaluates candidates on their understanding of how central bank policy rate changes (like the Repo Rate) flow down to the general public through mechanisms such as the Base Rate, MCLR, and EBLR.
Summary
The State Bank of India (SBI), Bank of Baroda (BoB), and Indian Overseas Bank (IOB) have announced a reduction in their Marginal Cost of Funds based Lending Rate (MCLR). This move is expected to lower Equated Monthly Installments (EMIs) for borrowers whose loans are linked to the MCLR regime, effectively making consumer and corporate borrowing cheaper. MCLR, introduced by the RBI in 2016 to replace the Base Rate system, acts as an internal benchmark for banks to ensure more transparent and effective transmission of the central bank's monetary policy actions to the real economy. Although newer retail loans are linked to the External Benchmark Lending Rate (EBLR), many existing and commercial loans continue to be priced based on MCLR.
Key Points
- State Bank of India (SBI), Bank of Baroda, and Indian Overseas Bank have reduced their Marginal Cost of Funds based Lending Rate (MCLR).
- A reduction in MCLR will result in lower Equated Monthly Installments (EMIs) for corporate and retail borrowers whose loans are pegged to this internal benchmark.
- MCLR was introduced by the RBI in April 2016, replacing the opaque Base Rate system, to improve the transmission of monetary policy changes to end consumers.
- MCLR is calculated based on four components: the marginal cost of funds, the negative carry on account of the Cash Reserve Ratio (CRR), operating costs, and tenor premium.
- While retail loans since October 2019 are largely pegged to the External Benchmark Lending Rate (EBLR), a significant portion of older floating-rate retail loans and corporate loans still rely on MCLR.
Important Terms
Marginal Cost of Funds based Lending Rate (MCLR)
Internal benchmark lending rate for banks, calculated based on the incremental cost of funds, operating expenses, and tenor premium. It replaced the Base Rate system in 2016.
UPSC context
GS Paper 3 (Economy); tested for understanding monetary policy transmission and banking sector reforms.
External Benchmark Lending Rate (EBLR)
A market-linked lending rate introduced in 2019, tying bank interest rates to external benchmarks like the RBI Repo Rate to ensure faster and more transparent rate transmission.
UPSC context
GS Paper 3 (Economy); critical for evaluating credit market efficiency and policy transparency.
Reserve Bank of India (RBI)
India's central bank and regulatory body responsible for formulating monetary policy, managing inflation, and supervising the banking sector and financial stability.
UPSC context
GS Paper 3 (Economy); fundamental for banking regulation, inflation targeting, and central banking functions.
Monetary Policy Transmission
The process by which a central bank's policy rate changes are passed through the financial system to impact borrowing costs, spending, and investment in the real economy.
UPSC context
GS Paper 3 (Economy); core topic for analyzing the effectiveness of RBI's monetary interventions.
State Bank of India (SBI)
India's largest public sector bank, playing a pivotal role in implementing government financial schemes and setting trends for market interest rates and liquidity.
UPSC context
GS Paper 3 (Economy); significant in discussions on Public Sector Banks (PSBs) and financial systemic stability.
Prelims Trap
"All new bank loans in India are now mandated to be linked to the External Benchmark Lending Rate (EBLR)."
The EBLR mandate (since 2019) applies strictly to retail and MSME loans. Corporate loans are still permitted to be priced using the internal MCLR regime.
Static Concepts Connected
What are the four core components of MCLR?
- Marginal Cost: The incremental cost of raising new funds, primarily through deposits and borrowings.
- Negative Carry: The opportunity cost of funds parked with the RBI as Cash Reserve Ratio (CRR), which earns zero interest.
- Operating Costs: The bank's day-to-day operational and administrative expenses.
- Tenor Premium: The additional risk premium charged by banks for lending over a longer duration.
How do internal and external benchmark rates differ in India?
- Internal Benchmarks: Calculated using the bank's own internal metrics (like cost of funds). Examples include Base Rate and MCLR. Transmission of RBI rate cuts is historically slow.
- External Benchmarks (EBLR): Linked to independent, external metrics (e.g., RBI Repo Rate, 91-day T-bill yield). Ensures near-immediate transmission of monetary policy changes to consumers.
Cross-Topic Patterns
Monetary transmission vs Inflation targeting
The coexistence of MCLR (corporate) and EBLR (retail) creates transmission lags, complicating the Monetary Policy Committee's (MPC) inflation-targeting mandate during rate cycles.
CRR's implicit tax on banks
The 'negative carry on CRR' component in MCLR structurally demonstrates how mandatory cash reserve ratios act as an operational cost or implicit tax on commercial banks.
Expect a multi-statement question contrasting MCLR components (marginal cost, negative carry) with EBLR mandates for MSMEs/retail loans.
Linked PYQs · 3
Linked PYQs · 3
- 2016PrelimsGS1
What is/are the purpose/purposes of the 'Marginal Cost of Funds based Lending Rate (MCLR)' announced by RBI? 1. These guidelines help improve the transparency in the methodology followed by banks for determining the interest rates on advances. 2. These guidelines help 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.
- 2023PrelimsGS1
Consider the following statements: Statement-I: In the post-pandemic recent past, many Central Banks worldwide had carried out interest rate hikes. Statement-II: Central Banks generally assume that they have the ability to counteract the rising consumer prices via monetary policy means. Which one of the following is correct in respect of the above statements?
- 2022PrelimsGS1
In India, which one of the following is responsible for maintaining price stability by controlling inflation?
