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15 MAY, 2017 (MAINS)

TODAYS ANSWER WRITING CHALLENGE FROM GS-III

 

Q1. What is Lending Rate based on Marginal Cost of funds? How is this different from the earlier Base Rate system? What will be the impact of the decline in MCLR on the economy? (200 words)

 

Please write the answer in comments section

  • Osho Korde

    Lending Rate: Base rate is the minimum rate set by the Reserve Bank of India below which banks are not allowed to lend to its customers.

    The marginal cost of funds(MCLR): It is simply the interest rate on the new loan balance.

    Lending Rate based on MCLR: The MCLR methodology for fixing interest rates for advances was introduced by the Reserve Bank of India with effect from April 1, 2016.

    How’s it different:
    • MCLR is based on marginal cost of funds, tenor premium, operating expenses and cost of maintaining cash reserve ratio.
    • The main factor of difference is the calculation of marginal cost under MCLR.
    • Marginal cost is charged on the basis of following factors.
    • interest rate for various types of deposits borrowings and return on net worth.

    Impact of the decline of MCLR:
    1. It will hamper the transmission of policy rates into the lending rates of banks.
    2. Lack of transparency in the methodology followed by banks for determining interest rates on advances.
    3. No scope of banks to become more competitive and enhance their long run value and contribution to economic growth.
    4. availability of bank credit at interest rates which are fair to borrowers as well as banks would not be achieved.

  • Ashish

    Marginal Cost of funds based Lending Rate (MCLR) refers to the minimum interest rate of a bank below which it cannot lend.
    MCLR actually describes the method by which the minimum interest rate for loans is determined by a bank – on the basis of marginal cost that is incremental cost of arranging one more rupee to the borrower.
    The MCLR methodology for fixing interest rates has been introduced by the RBI for effective implementation of monetary policy since April 2016. Prior to MCLR system, different banks were following different methodology for calculation of base rate.
    MCLR aims
     To improve the transmission of policy rates into the lending rates of banks.
     To bring transparency in the methodology followed by banks for determining interest rates on advances.
     To ensure availability of bank credit at interest rates fair to borrowers as well as to banks.
     To enable banks to become more competitive and enhance their long run value and contribution to economic growth.

    Base Rate vs MCLR
    Base rate calculation is based on cost of funds, minimum rate of return, i.e profit, operating expenses and cost of maintaining cash reserve ratio while the MCLR is based on marginal cost of funds, tenor premium, operating expenses and cost of maintaining cash reserve ratio.
    The main factor of difference is the calculation of marginal cost under MCLR. Marginal cost is charged on the basis of following factors- interest rate for various types of deposits, borrowings and return on net worth.

    Impact of lower MCLR on the economy
    Greater credit off take by the prospective borrowers
    Boost to the real estate and infrastructure due to lower cost of capital and increased demand
    However greater money supply may also lead to inflationary tendencies in the economy