Hike in lending rates - high costs or risks?

 

Hike in lending rates: Is it justified?

Increase in MCLR: Last week, major banks have increased their MCLR  (marginal cost of funds based lending rate) across various tenors by 5 and 10 basis points. The lending rates of existing borrowers and as a consequence their repayment obligations/ EMIs, will see an upward revision in the immediate future (depending on their lending rate linkage with the relevant MCLR tenor rate). The good news is that for the time being, there is no change in the lending rates, which are linked to the external benchmark rates like repo rate, etc.

Background: In a scenario, where RBI

·        revised its inflation projection from 5.2% to 5.7% for 2022-23,

·        indicated that focus, from now on, shifts to inflation control and

·    raised the interest rate for monies placed by banks with itself (standing deposit facility at 3.75% as against reverse repo at 3.35%) 

the banks have announced upward revision in MCLR.  Though the increase is moderate, the timing is perfect. And the banks have left the RLLR (Repo rate linked lending rate) static since the repo rate is unchanged, which definitely helped in creating an impression that MCLR followed the cost pattern. Coming closely on the heels of a spike in G-sec yields and increase in interest rate for debenture/bonds, the market appears to have accepted the increase quietly. So the cycle of increased lending rates has begun.

What is MCLR? MCLR is an internal reference rate to which the interest rates to the borrowers are linked. The main components of MCLR are marginal cost of funds, operating costs, tenor premium and negative carry on CRR. 

Contributing factor in the increase in MCLR: Of the above, CRR remains unchanged at 4%, banks have reported decline in cost to income ratio and GNPA has moderated considerably as compared to previous periods. Hence it is unlikely that there is increase in cost due to the three factors viz. operating costs, tenor premium and negative carry on CRR. That leaves one to consider whether there is any increase in marginal cost of funds (MCF) in the immediate past. As per RBI guidelines, marginal cost of funds has two components – marginal cost of borrowings and return on net worth. Marginal cost of borrowings is translated into 92% of MCF and return on net worth is restricted to 8% of MCF. So, increase in marginal cost of borrowings, in all probability, appears to have influenced the decision of banks to increase their MCLR.

Whether increase in MCLR justified?:  MCLR is discussed in the monthly/quarterly in the ALCO/Risk Committee meetings of the respective banks and maintenance of status quo/change in rates is decided. The cost factors of individual banks are different. 

Notwithstanding the above, my view is that MCLR should have been left unchanged as 

I. Marginal cost of borrowings continues to favour the banks for the following reasons:

1.   CASA ratio, an important factor in deciding cost of deposits, has gone up substantially, across all the banks

2.   Savings Bank interest rate has been reduced between 80 to 130 bps in the last 1 year. Balances up to Rs.1 lac, which forms the majority of savings deposits, carry interest at equal to or less than 3% in most of the banks.

3.   Median interest on term deposits dropped more by 205 bps in comparison with secured loans, which came down by 178 bps for new loans and still lower for existing loans.

4.   Bulk deposits or high cost deposits have been replaced by healthy retail deposits.

5.   High level of GNPAs was a major factor in increasing interest rates on loans or not passing on the benefit of reduction in policy rate to the borrowers in the past. This was because, the bankers were not earning interest on GNPA and had to make additional provision, which had an impact on retained earnings. This is not the case now, as GNPAs of almost all the banks are on a steep decline curve.

(I refrain from commenting on the increased earnings in SDF, yields in G-sec. as they have nothing to do with MCLR calculations)

II. The Indian economy, which was limping back to normalcy thanks to containment of COVID-19 to manageable levels, faces uncertainties on account of increase in price of essentials and commodity supply bottlenecks due to the prolonged Russia-Ukraine War. It would have been better, had the banks allowed status quo to continue in the lending rates, so that the rejuvenated credit growth continues.

V.Viswanathan

26th April 2022.


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