What the increase in MCLR means for you, your loan

State Bank of India (SBI), India’s largest commercial bank, recently raised the marginal cost of funds-based lending rates (MCLR) for the first time in three years, signalling that the soft rates regime that has prevailed since 2019 may be over.

About Marginal Cost of Funds-Based Lending Rates (MCLR):

• The marginal cost of funds-based lending rate (MCLR) is the minimum interest rate that a bank can lend at.
• MCLR is determined internally by the bank depending on the period left for the repayment of a loan.
• The RBI introduced the MCLR methodology for fixing interest rates from 1 April 2016. It replaced the base rate structure, which had been in place since July 2010.
• It is applicable to fresh corporate loans and floating rate loans taken before October 2019.
• RBI then switched to the external benchmark linked lending rate (EBLR) system where lending rate is linked to benchmark rates like repo or Treasury Bill rates.

What changes will be seen after increase in MCLR?

• EMIs are set to rise
  • As a result of the increase in MCLR, borrowers who have taken home, vehicle, and personal loans will find their equated monthly instalments (EMIs) rising in the coming months.
  • With the RBI set to withdraw the accommodative policy (the willingness to expand money supply to boost economic growth), lending rates are expected to rise further in the coming months.
• Interest rates will rise
  • According to bankers, the gradual tightening of money supply in the financial system is expected to push up interest rates.
  • The “extraordinary” liquidity measures undertaken in the wake of the pandemic, combined with the liquidity injected through various other operations of the RBI have left a liquidity overhang of the order of Rs 8.5 lakh crore in the system.
  • With retail inflation hitting 6.95% in March and wholesale inflation at 14.55%, the central bank is expected to take measures to bring down prices.
  • The tightening of the accommodative policy is normally accompanied by a rise in interest rates in the system. 
• Banks expect a repo rate hike
  • Banks expect the repo rate — the main policy rate — to go up from June onwards as the RBI seeks to suck out liquidity from the system to rein in inflation.
  • In April 2022, the RBI’s Monetary Policy Committee restored the policy rate corridor under the liquidity adjustment facility to the pre-pandemic width of 50 bps by introducing the Standing Deposit Facility (SDF) at 3.75 as the floor of this corridor.
  • SDF is an additional tool employed by the RBI to absorb excess liquidity. In essence, overnight rates were hiked to 3.75%.
• Deposit rates will also rise
  • According to the SBI research report, deposit rates are likely to “increase meaningfully” over the next one-two months.
  • SBI now offers 5.10% interest in the 1-2-year bucket. This means a fixed deposit holder is sitting on a negative return of 185 basis points, as inflation is now at 6.95%.
  • Deposit rates in the 1-3-year bucket have fallen from 8.75-9.25% in 2013-14 to 4.90-5.15% in 2021-22, according to an RBI study on five major banks.