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Is there a substitute for MCLR?

LiveMint logoLiveMint 11-09-2017 Vivina Vishwanathan

The central bank is all set to take a relook at marginal cost of funds based lending rate (MCLR). Should banks move to a system based on Mumbai Interbank Offer Rate (MIBOR) for deposits and credit? We spoke to experts about this.

Rajeev Mohan, senior executive VP–treasury, Kotak Mahindra Bank

The MIBOR, from being polled, has come a long way to being a statistically compiled basis for actual transactions. Would this be an ideal benchmark for anchoring floating rate loans and deposits? Theoretically, floating rate anchors should not only be well understood by all parties (borrowers, depositors, banks) but the anchors should also be appropriate for all. For small depositors and borrowers, having the inherent volatility of overnight money market rates in deposit and loan rates may not be practical. Large borrowers and depositors, like banks, may be qualified and financially able to structure their flows in such a manner so as to benefit from anchoring to this benchmark.

To the extent of liquidity and addressing interest rate gaps in asset liability management, usage of MIBOR as a benchmark for floating rate is possible for savvy investors and borrowers. However, about 750 resets over a 3-year period is cumbersome for them as well.

This does not mean that floating rate loans and deposits are not appropriate. But there isn’t a consensus on the most suitable benchmark yet.

For banks, it is a question of which benchmark is best suited for a wider offering of loans and deposits. As benchmarks gain wider acceptance, floating rates linked to external benchmarks are also expected to gain wider acceptance.

R. Sivakumar, head-fixed income, Axis Mutual Fund

Being an overnight rate, it may not be appropriate to benchmark all rates to MIBOR. It may be appropriate to look at pricing different tenure loans against appropriate tenor benchmarks. For instance, mortgages could be benchmarked to 10-year government securities. They could ask banks to price loans on market benchmarks plus appropriate spreads, rather than a bank specific benchmark for faster transmission of rates. Futures and other derivatives indices will also take off as people find opportunities to move from fixed to floating and floating to fixed and also hedge their interest rates using available benchmarks. Today, given the lack of correlation between bank lending rates and market benchmarks, a borrower can’t hedge her borrowing risk using futures available benchmarks. But if loans are linked to these benchmarks, it opens opportunities for borrowers and investors to manage their risk better. The idea of moving loans to floating rates is to enable monetary policy transmission. With MCLR, it still comes down to each bank’s cost of funding rather than the market interest rate, which are more sensitive to changes in monetary policy than bank deposit rates. Consequently, if lending rates are linked to deposit rates, they will move less than what monetary policy seems to suggest. First leg is benchmarking and second is reset.

Abheek Barua, chief economist, HDFC Bank

Banks stick to the MCLR formula very closely but there are two issues: One, there are rates that are still being priced on the base rate. I think RBI is more concerned about that. Base rate captures the changes in policy rates. Two, there is sub-MCLR pricing on the basis of market rate. The MCLR itself has been open to interpretation. But it is a stricter formula than the base rate.

The Reserve Bank of India (RBI) is concerned about all these issues.

When the central bank said that it would look at transmission and where it was failing, I think it was referring principally to base rate-linked loans and also to sub-MCLR pricing. There are some problems related to MCLR also.

Banks have already been looking at long-term benchmark rates and there has been a misinterpretation of the RBI’s diktat. When RBI announced base-rate linked pricing, it said that some base rate pricing would be allowed if it was linked to the market rate. When it announced the MCLR, this was not allowed. MCLR seems to be RBI’s rate of choice.

There are some aberrations that are still going on in the market and the central bank wishes to correct these.

In terms of overnight rates, there is a possibility that short-term rates can be linked to it. The RBI has to take a broader call on what it will allow to be linked to market prices.

Rajni Thakur, economist, RBL BankBank rates have come down; MCLR rates have come down gradually, and most of the drop has happened post-demonetization. But the average fall has been of 130-150 basis points (one basis point is one-hundredth of a percentage point). This is not to the tune of bank rates precisely because MCLR-based lending is a gradual process and it doesn’t happen in one go. Banks lend in various structures, such as on base rate or on fixed rate. Many public sector banks have personal loans or auto loans based on fixed rates. So, only when rates are due for reset is there a gradual move towards MCLR. And MCLR for any bank is a factor of the cost of funding, operations, and return on networth.... Even if we assume that there is no rate cut from the central bank, we are clearly looking at a further reduction of 30-40 basis points in MCLR over the cycle. With MIBOR, there are still questions. There has to be an alternative. MIBOR has a lot of issues structurally since it is an index-based rate. I don’t expect a MIBOR kind of index to come back. A 10-year g-sec is completely linked to the market and I am not sure if a bank can get into that because it has a lot of volatility. It (the alternative) has to be a combination of short-term and long-term policy rates to be a stable rate. Not exactly a g-sec, but a bigger component which has g-sec as one of its parts.

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