• In recent move, State Bank of India has decided to link its savings deposits rates and short-term loans to the RBI’s repo rate.
• The new rates linked the external benchmark rate of the repo rate, will be effective 1 May,2019.
Repo Rate: Repo rate is the rate at which the RBI lends funds to banks.
Marginal cost of funds based lending rate: MCLR is an internal benchmark rate that depends on various factors such as fixed deposit rates, source of funds and savings rate.
• In 2016, the Marginal cost of funds based lending rate (MCLR) replaced the base rate regime to provide transparency in the transmission of monetary policy decisions.
• From 2016, all bank loans are linked to MCLR and the price of loan comprises the MCLR and the spread or the bank’s profit margin.
• In 2018, RBI directed the banks to price their loans against an external benchmark instead of the internal benchmarks.
• External benchmark rates options to the banks:
o RBI repo rate
o The 91-day Treasury bill yield
o The 182-day Treasury bill yield
o Any other benchmark market interest rate produced by the Financial Benchmarks India Pvt. Ltd
Financial Benchmarks India Pvt. Ltd (FBIL)
• FBIL is jointly owned by Fixed Income Money Market & Derivative Association of India, Foreign Exchange Dealers Association of India and the Indian Banks’ Association (IBA), was formed in 2014 as a private limited company.
• Aim: to develop and administer benchmarks relating to money market, government securities and foreign exchange in India.
Problems with MCLR–based system:
• Lack of required transmission of policy rates: Due to internal benchmarking of loan price, policy rate cuts often don’t reach the borrowers.
• Non-Transparency: The MCLR system is not transparentsince it is an internal benchmark that depends on the way a bank does its business.
• The SBI will link the savings bank deposits, with balance above Rs 1 lakh to the repo rate with current effective rate being 3.50 percent per annum, which is 2.75 percent below the present repo rate.
• All cash credit accounts and overdrafts with limits above ₹1 lakh will also be linked to the repo rate, plus a spread of 2.25% (amounting to 8.5%).
• SBI will charge a risk premium on these loans, over and above the floor rate of 8.5%, based on the risk profile of the borrower, similar to the current practice.
• SBI savings account rates and interest rate on a few loans will now change as and when RBI changes its repo rate
• However, home loan rates will still be determined by the MCLR rates, which are expected to fall as savings deposit rates have a substantial weightage while determining MCLR.
Implications of the move
• The new system is expected to bring in more transparency in fixing lending rates since every borrower will know the fixed interest rate and the spread value decided by the bank.
• It will help better transmission of policy rate cuts which means an RBI rate cut will immediately reach the borrowe