MARGINAL COST OF FUNDS METHODOLOGY FOR INTEREST RATE ON ADVANCES: In order to have more effective transmission of Monetary Policy, RBI has proposed to set base rate on the basis of Marginal Cost of Funding. The draft guidelines which were circulated had been finalized. All rupee loans and credit limit sanctioned w e f April 2016 onwards will be having the new internal benchmark rate as reference rate and it has been rechristened as Marginal Cost of Funds based Lending Rate replacing Base Rate.
The banks will review and publish their MCLR of different maturities every month on a pre-announced date. The banks can offer loans with reset clause. The MCLR as on date of sanction will be applicable till the date of next reset. Existing loans and credit limits linked to Base Rate will continue till repayment or renewal.
The aim is transmission of policy rates into lending rates i.e. lending rates by banks should move in consonance with policy rates announced by RBI. The RBI has observed that despite cut in policy rates, the benefit is not passed on to the customer as banks do not reduce their lending rates thereby denying the public effect and benefit of cut in policy rates.
Calculation of Base Rate based on Marginal Cost of Funding: The marginal cost of funding should determine the Base Rate of banks. The component of Base Rate will be
- i) Cost of funds
- ii) Negative carry over CRR and SLR Requirements
iii) Unallocated Overheads and
- iv) Average Return on Networth.
- i) Calculation of Cost of Funds:- Marginal cost of funds should be used for calculating cost of funds. The cost of deposit should be calculating taking into consideration latest card rates payable on different maturities on current, saving and term deposits. The cost of borrowing should be calculated based on average rate of borrowing during the last month preceding the date of review. For simplicity, let us assume a bank has total deposit of Rs.100. Rs.10 (i.e. 10%) current deposits where interest payable during the last month is 0%, Rs. 30 (i.e. 30%) savings deposit where last month interest payable is 4.00%, and Rs. 25.00 (25%) term deposit of maturity of 1 years where last interest payable is 6% and Rs.35.00 (i.e. 35%) term deposit of 3 years maturity where last interest payable is 7%. The marginal cost will be calculated as under:-
Particular of deposit as %age of total funds Rates last offered Marginal cost
Current Deposit 10 0 0
Saving Deposit 30 4 1.20
Term Deposit 1 Year 25 6 1.50
Term Deposit 3 Year 35 7 2.45
Marginal Cost of funding 5.15
- ii) Negative Carry on CRR and SLR: Since CRR carries 0% interest, and sometimes SLR return can be lower than cost of funds, there can be negative carry on CRR and SLR.
iii) Unallocable Overheads: The unallocable overhead costs should comprise solely of costs incurred for the bank as a whole and, hence, not allocable to any particular business activity/unit. These components would be fixed for 3 years, subject to review thereafter.
- iv) Average Return on Networth: Average return on net worth is the hurdle rate of return on equity determined by the Board or management of the bank. It is expected that the component representing ‘return on networth’ will remain fairly constant and any change would be made only in case of a major shift in the business strategy of the bank.