Concerns related to India’s interest rates: Last-mile transmission a big hurdle to policy rate cut

Source: The post concerns related to India’s interest rates has been created, based on the article “Last-mile transmission a big hurdle to policy rate cut” published in “Live mints” on 13th April 2024.

UPSC Syllabus Topic: GS Paper 3- Indian economy – mobilisation of resources

News: The article discusses why India’s central bank, the RBI, hasn’t reduced its main interest rate. Despite the RBI increasing this rate before, banks haven’t fully passed these increases to borrowers. This incomplete adjustment is one reason the RBI is cautious about changing rates now. Concerns related to India’s interest rates

For details information on marginal cost of funds-based lending rate read Article 1, Article 2

What are the major concerns related to India’s interest rates?

Incomplete Transmission: Despite the RBI increasing the repo rate by 250 basis points, banks have only raised the weighted average lending rate on fresh loans by 185 basis points, indicating incomplete transmission.

EBLR vs. MCLR: Loans tied to the External Benchmark-based Lending Rate (EBLR) quickly adjust with the repo rate, while those tied to the Marginal Cost of Funds-based Lending Rate (MCLR) lag behind. For instance, between May 2022 and March 2024, the median one-year MCLR only rose by 155 basis points, compared to a 250 basis point increase in the repo rate.

What are the reasons for Slow MCLR Adjustment?

Complex Pricing Mechanism: MCLR-based loans factor in the bank’s cost of deposits and other margins, making rate adjustments more complex and slower than EBLR-linked loans.

Competition Concerns: Banks are cautious in raising MCLR rates due to fears of losing loan accounts to competitors, affecting their market share. This hesitance impacts the rate adjustment pace.

Selective Deposit Rate Increases: Banks have raised rates mainly for short-term deposits, affecting the cost basis for MCLR and subsequently delaying the transmission to MCLR-linked loan rates.

What is the RBI’s View on the Transmission of Rate Changes?

Ongoing Transmission: The RBI acknowledges that the transmission of rate changes to lending rates is still in progress, indicating a gradual process.

Goal of Fuller Transmission: The central bank is committed to ensuring a fuller transmission of policy actions, highlighting its efforts to make interest rate changes effectively impact lending rates.

Anchoring Expectations: The aim of anchoring household inflation expectations through effective rate transmission is indeed a part of the RBI’s strategy, as outlined by the Deputy Governor.

Question for practice:

Discuss the reasons behind the slow adjustment of Marginal Cost of Funds-based Lending Rate (MCLR) in India.