October 6, 2016 12:45:49 am
The Reserve Bank of India (RBI) has said banks will need to review the implementation of the Marginal Cost of Funds based Lending Rate (MCLR) to facilitate effective transmission of rate cuts.
Structural and cyclical factors impeding transmission to bank lending rates, particularly stressed balance sheets of banks and sluggish credit growth, may require a review of the MCLR implementation by banks, in the context of significant softening of long-term yields, the RBI has said in its Monetary Policy Report-October 2016, released ahead of the 4th bi-monthly policy statement on Tuesday.
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The MCLR system introduced on April 1, 2016 was designed taking into account limitations of both the BPLR (benchmark prime lending rate) and the base rate regimes. Under the MCLR system, banks determine their benchmark lending rates linked to marginal cost of funds. The MCLR consists of four components: marginal cost of funds (i.e. marginal cost of borrowings comprising deposits and other borrowings, and return on net worth), negative carry on account of cash reserve ratio (CRR), operating costs and term premium/discount for prescribed maturities.
The MCLR plus spread is the actual lending rate for a borrower. The spread comprises two components — business strategy and credit risk premium. In principle, the role of each component of the MCLR can be monitored and analysed. Different components of the MCLR vary widely across banks at any point in time.
The transmission of monetary policy is marked by long and variable time lags with asymmetric market responses to policy impulses — generally higher during a tightening phase and lower during an easing phase, irrespective of the prevailing regime for pricing of credit. Since January 2014, the RBI had slashed Repo rate by 175 basis points but banks have passed on just around 80 bps.
The RBI also analysed the reasons hindering transmission of rates. First is the fixed interest rates offered on savings deposits (though deregulated) which, along with current accounts, constitute around 35 per cent of aggregate deposits, thereby stifling transmission to more than a third of deposits. Saving rates have not come down in the last two years. The second point highlighted by the RBI is that no reduction in interest rates has happened on small savings in Q2 of 2016-17, followed by a marginal reduction of 10 bps in Q3, notwithstanding a notable decline in G-sec yields.
The third issue is stressed asset quality of banks and pricing of risk premium reflecting risk aversion. Banks, which are trying to clean up their balance sheets have reported a 96 per cent jump in non-performing assets to Rs 629,774 crore at the end of June 2016 against Rs 320,553 crore in the same period last year. The sharp rise follows RBI’s instruction to banks to classify close to 130 stressed accounts as NPAs and make adequate provisioning for them.
The fourth issue is sluggish bank credit demand. The non-food credit growth in August was at 8.2 per cent on year-on-year basis. Industry’s credit offtake remained weak, declining by 0.2 per cent YoY. Infrastructure loans dipped by 4.2 per cent year-on-year as power sector loans fell 9.7 per cent and growth in the telecom sector declined by 4.3 per cent.
However, the RBI says easy liquidity conditions engendered by the central bank’s operations should enable the smooth transmission of the policy action. “Furthermore, banks should find added impetus for better transmission by the recent downward adjustment in small savings rates,” the RBI report said. “In this scenario, RBI would continue to manage liquidity proactively and consistent with the stance of monetary policy, while taking timely and appropriate measures to insulate the system from shocks.”
Clearly the RBI does not share the same enthusiasm of banks about the speed of transmission of rates. “With MCLR already stabilised, the pass through of this cut is expected to be quite swift,” said Ashwani Kumar, chairman of Indian Banks’ Association, on Tuesday’s rate cut. SBI chairman Arundhati Bhattacharya said: “Banks will continue to transmit rates based on evolving liquidity scenario.”
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