Interest rate transmission: PLR, MCLR, RLLR, EBLR – Complication doesn’t work

Let banks them take their own pricing decisions, banking is a business. Monetary transmission may be RBI’s desire but it should not kill banking business.

  • N R Bhusnurmath

SBI has announced that with effect from 10th June it is cutting its lending rates.  In the good old days (read before the Reserve Bank of India (RBI) decided to muddy the waters by interfering in what should have been a commercial decision of banks by telling them how they should price their loans) a single sentence would have sufficed to convey the news that the largest commercial bank in the country, State Bank of India (SBI) was going to cut its lending rates. What we got, instead, is a long-winded press release that has only left borrowers more confused than ever.

The reason is simple. RBI determined, if largely unsuccessful, to ensure transmission of its interest rate signals, has mandated one system of loan pricing after another; MCLR, RLLR & the EBLR. These came after the prescriptions such as PLR, BPLR and the Base Rate! Banks are now saddled with a plethora of lending rates.

When RBI deregulated banks’ lending rates in 1994 as part of the financial sector reforms, it introduced the concept of Prime Lending Rate (PLR), the rate charged to their best customers or prime customers. This was a welcome step as PLR was logical and in vogue in the developed financial markets. Rates for all other customers were to be determined based on their credit-risk. Subsequently, to take care of the issues that cropped up in its roll-out, PLR was replaced by the ‘Base Rate, Here started the problems of micro regulation. The central bank mandated the formula for the Base Rate.

But, in a scenario where banks’ lending rates are a function of their deposit interest rates (since, unlike Western banks that are dependent on wholesale money markets, banks in India are dependent on retail deposits) banks did not seem to heed RBI’s “signals”. The fatwa from RBI did little to improve monetary transmission.

However, in April 2017, the desire of RBI governor to ensure monetary transmission overtook the need to leave banks to take their own pricing decisions. Miffed with its seeming inability to ensure complete transmission and unwilling (unable?) to understand the commercial banks perspective, RBI then directed banks to specify their Marginal Cost Lending Rate (MCLR) again calculated using a prescribed formula and base its lending rate structure on the MCLR. Never mind that in an environment where deposits are contracted for a fixed rate of interest, the concept of MCLR has no relevance whatsoever.

Not surprisingly, banks found their own way of getting around the MCLR constraint. They had to! After all it was a matter of survival for them.

So then came the turn of the repo-linked lending rate (RLLR); completely oblivious to two facts – a) the repo rate is a short-term, usually overnight, rate whereas loans are for varying and longer tenures and b) the amount available under RBI’s repo window is limited and linked to the quantum of excess SLR securities held by banks.

Which brings us to RBI’s most recent attempt, the external benchmark linked (EBLR) interest rate. This is, perhaps, the least bad alternative if the RBI has to lay down a base rate. Except that it does not answer the more important question of why should the central bank stipulate how banks should fix their lending rates. No other central bank does it; so why should RBI?

As a regulator, RBI should confine itself to ensuring there is transparency and competition among banks and leave the rest to the market

  • N R Bhusnurmath is Adjunct Professor of Finance & Banking at IMT Ghaziabad. Views expressed are the author’s own.

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