Context:

India’s largest bank State Bank of India (SBI) reduced its marginal cost of funds-based lending rate (MCLR).

About:

• The marginal cost of funds-based lending rate (MCLR) is the minimum interest rate that a bank can lend at.
• MCLR is a tenor-linked internal benchmark, which means the rate is determined internally by the bank depending on the period left for the repayment of a loan.
• The RBI introduced the MCLR methodology for fi xing interest rates from 1 April 2016.

MCLR is calculated

• The four main elements of MCLR are made up of the following:

1.Tenor premium

The cost of lending varies from the period of the loan. Higher the duration of the loan, higher will be the risk. In order to cover the risk, the bank will shift the load to the borrowers by charging an amount in the form of premium. This premium is known as the Tenure Premium. 

2. The marginal cost of funds

The marginal cost of funds is the average rate at which the deposits with similar maturities were raised during a specifi c period before the review date. This cost will refl ect in the bank’s books by their outstanding balance. The marginal cost of funds has several components like the Return on Net Worth and the Marginal Cost of Borrowings. Marginal Cost of Borrowings takes up 92% while the Return on Net Worth accounts for 8%. This 8% is equivalent to the risk of weighted assets as denoted by the Tier I capital for banks.

3. Operating Cost

Operational expenses include the cost of raising funds, barring the costs recovered separately through service charges. It is, therefore, connected to providing the loan product as such.

4. Negative carry on account of CRR

Negative carry on the CRR (Cash Reserve Ratio) takes place when the return on the CRR balance is zero. Negative carry arises when the actual return is less than the cost of the funds. This will impact the mandatory Statutory Liquidity Ratio Balace (SLR) – reserve every commercial bank must maintain. It is accounted negatively as the bank cannot utilize the funds to earn any income nor gain interests.

External Benchmark based Lending Rate (EBLR)

• In this system, the interest rate is pegged to any external benchmark. RBI has notifi ed the following benchmarks (used as External Benchmark Rate) –
• Reserve Bank of India policy repo rate.
• Government of India 3-Months Treasury Bill yield published by the Financial Benchmarks India Private Ltd (FBIL).
• Government of India 6-Months Treasury Bill yield published by the FBIL.
• Any other benchmark market interest rate published by the FBIL. SBI calculates its EBLR as; EBLR = External Benchmark Rate + Credit Risk Premium.