Explained: What the MCLR Increase Means for You, Your Loan

The State Bank of India (SBI), India’s largest commercial bank, on Monday raised the marginal cost of funds-based lending rates (MCLR) for the first time in three years, signaling that the rate regime flexible that prevails since 2019 could be ended.

Your NDEs are about to increase

The SBI increased the MCLR by 10 basis points (bps) across all mandates to 7.1% (from 7% previously); it is now slightly below the 7.25% of HDFC Bank, Punjab National Bank and ICICI Bank. Bank of Baroda, Axis Bank and Kotak Mahindra Bank increased their MCLRs by 5 basis points each across all mandates. Other public and private banks are expected to increase MCLRs in the coming days.

The MCLR, which RBI instituted with effect from April 1, 2016, is the lowest interest rate a bank or lender can offer. It applies to new business loans and variable rate loans taken out before October 2019. RBI then moved to the External Benchmark Linked Lending Rate (EBLR) system in which the lending rate is linked to benchmark rates such as repo rates or treasury bill rates.

Due to the increase in MCLR, borrowers who have taken out home, car and personal loans will see their monthly equivalent payments (EMI) increase in the coming months. As the RBI prepares to withdraw its accommodative policy (the desire to increase the money supply to stimulate economic growth), lending rates are expected to rise further in the coming months.

MCLR-linked loans accounted for the largest share (53.1%) of banks’ loan portfolio in December 2021. The rise in MCLR comes after banks’ median one-year MCLR fell 95 basis points between March 2020 and January 2022. The decline in MCLRs over the past three years and the periodic reset of these loans at lower rates has helped existing borrowers as banks have extended the benefits to them by reducing the WALR (Weighted Average Loan Rate). loans) on rupee loans more than policy repo rate reductions during the EBLR period.

Banks have linked their EBLR to the RBI’s repo rate, which has fallen from 5.40% to 4% since October 2019. When the RBI raises the repo rate, the EBLR will rise and vice versa. The share of EBLR loans in total advances was 39.2% in December 2021, according to RBI.

Interest rates will go up too

According to bankers, the gradual tightening of the money supply in the financial system should push up interest rates. The “extraordinary” liquidity measures undertaken in the wake of the pandemic, combined with the liquidity injected through various other RBI operations have left excess liquidity in the order of Rs 8.5 lakh crore in the system.

With retail inflation hitting 6.95% in March and wholesale inflation at 14.55%, the central bank is expected to take action to lower prices. The tightening of accommodative policy is normally accompanied by a rise in interest rates in the system. The US Federal Reserve recently announced policy tightening and raised interest rates. The next round of rate hikes is expected towards the end of May-June. However, the rise in rates should be gradual.

Banks expect repo rates to rise

Banks expect the repo rate – the main benchmark rate – to rise from June as the RBI seeks to suck liquidity from the system to contain inflation. Indicating upward pressure on interest rates, the yield on benchmark 10-year government bonds hit 7.15%, rising 24 basis points in less than two weeks. On the other hand, the cost of funds is expected to rise, prompting banks to raise lending rates.

On April 8, the RBI’s Monetary Policy Committee restored the Policy Rate Corridor under the Liquidity Adjustment Facility to the pre-pandemic width of 50 basis points by introducing the Standing Deposit Facility ( SDF) at 3.75 as the floor of this corridor. The SDF is an additional tool used by the RBI to absorb excess liquidity. Essentially, overnight rates were raised to 3.75%.

In response to the 250 basis point reduction in the key repo rate since February 2019 – when the current easing phase began – WALRs on fresh and outstanding loans in rupees have decreased by 213 basis points and 143 basis points respectively. This cycle is being reversed.

The hike could take place in June

Analysts and bankers expect the RBI to raise the repo rate by 4% in the June policy review. “We now expect a rate hike of 25 basis points each in June and August, with a cumulative rate hike of 75 basis points in the cycle. As the spread between bond yields and repo rates increases in a rising interest rate cycle, bond yields could reach 7.75% by September,” said an SBI research report.

RBI has kept the repo rate unchanged for the past 11 policy reviews in a bid to boost growth. Interest rates on loans and deposits are expected to rise across the board when the repo rate is finally raised in June or August, a banking industry source said.

Both policy rates were last cut in May 2020 with a 4% repo and a 3.35% reverse repo, and have since been held at these historic lows. “Deposit rates have already started to rise, and with a lag, lending rates could rise in the first half of fiscal 2023,” said YS Chakravarti, MD and CEO, Shriram City Union Finance.

“The change in tone at today’s meeting and the narrowing of the LAF corridor will set markets up for repo rate hikes, which are expected to be 50 to 75 basis points in fiscal 2023, beginning by the June monetary policy review,” noted ratings firm Crisil. said on April 8. The pace of tightening will be guided by surprises emanating from inflation and external risks, he said.

Deposit rates will also increase

According to the SBI research report, deposit rates are expected to “significantly increase” over the next two months. SBI now offers a 5.10% stake in the 1-2 year tranche. This means that a fixed deposit holder is sitting on a negative yield of 185 basis points, as inflation is now at 6.95%. Deposit rates in the 1-3 year tranche fell from 8.75-9.25% in 2013-14 to 4.90-5.15% in 2021-22, according to an RBI study of five major banks. Despite low interest rates, deposit growth increased during the pandemic years, from 8% in FY20 to 11% in FY21. deposit up to 10 basis points since February of this year.

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