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Pro-Consumer Lending Rate!

Since interest rates are key to home buying, passing on rate cuts to consumers will help boost housing sales

Photo Credit : Reuters

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In April, 2016, when the Reserve Bank of India (RBI) introduced the advanced MCLR (Marginal Cost of Funds Based Lending System), replacing the old Base Rate System, it was touted as an improved and robust mechanism that would ensure faster transmission of rate cuts to borrowers.

No one could have imagined then that a year-and-a-half later, the RBI panel would recommend that the system be replaced, on the grounds that it was not delivering the desired results. Banks were laggards in transmitting rates cuts to borrowers. In the preceding two years, the RBI had effected cumulative interest rate cuts of about 200 basis points (bps), but banks had only passed on an average of 130 bps to borrowers.

The RBI had migrated to the MCLR lending system for the benefit of borrowers (home and auto loan takers). Under the base rate system, banks were reluctant to change interest rates with every small repo rate cut and only changed rates when the RBI effected a substantial rate cut.

The base rate system was, therefore, not flexible enough to pass on interest rate cuts by the RBI at the desired pace and magnitude. Under the MCLR system, it was mandatory for banks to consider the repo rate, while calculating or fixing their MCLR. It was also mandatory for banks to readjust interest rates on a monthly basis.

However, the Marginal Cost of Funds Based Lending System also turned out to be flawed and did not prove very effective. It turned out that banks were abysmally slow in shifting current borrowers to this new improved system. The study group set up by the RBI to judge the efficacy with which its interest rate cuts were being transmitted to consumers and to suggest improvements in the system, suggested that greater transparency could be brought into the system by linking bank lending rates directly to market determined benchmarks.

It also suggested that multiple systems be done away with and that the regulator (the RBI) strictly enforce rules through greater surveillance. Here, it is pertinent to mention that the RBI had remained a silent spectator all the while that banks refused to follow or simply violated its prescribed procedures and guidelines.

 The RBI panel has also recommended that all current borrowers charged under the base rate/MCLR system be shifted to the external benchmark rate within a year of its introduction. The RBI is yet to take a call on the suggestions of the committee, though.

Some financial experts like Akhil Bansal, Deputy CEO of KPMG India, believe that a vibrant corporate bond market should be developed. Such a market, he believes, could play a significant role in speeding up the transmission of interest rates by banks and ensure that the benefits of interest rate reduction be passed on quickly and fully to borrowers.

Finally, it is pertinent to point out that the proposed system to link lending rates to market determined benchmarks will ultimately depend on the market regulator — the RBI. The success of any new system will depend on whether the RBI truly plays the role of a regulator.

The RBI will have to ensure that banks follow the rules. It will have to ensure that banks are not allowed to get away with any lapses or calculated manipulations to deprive borrowers of the benefits of interest rate cuts that it effects.

Since interest rates are key to home buying, passing on rate cuts to

consumers will help boost housing sales in the otherwise depressed real estate market. It will in turn, help realise the government’s flagship mission of ‘Housing for All’. 

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.


Vinod Behl

The author is senior real estate media professional

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