With the aim of improving the transmission of interest rates changes, the Reserve Bank of India (RBI) has decided to harmonise the methodology of determining benchmark rates by linking the Base Rate to the MCLR with effect from April 1 this year. However, prima facie, while this may appear that existing borrowers still stuck at base rate could see their equated monthly instalments (EMIs) falling, this may not be the case with interest rates likely to rise in the coming months.

“The harmonisation of benchmark rates may not help borrowers whose loans are still linked to the base rate, given the upward bias in interest rates,” said DK Joshi, chief economist at Crisil.

Under the MCLR – the minimum lending rate below which a bank can't lend to customers – system, the rate is calculated by using the cost incurred on incremental deposits, not average cost of deposits. The interest rate charged under the base rate is higher compared to the MCLR regime. Borrowers under the base rate regime typically have to pay a fee to switch to the MCLR regime.

The RBI had introduced the Marginal Cost of Funds based Lending Rates (MCLR) system with effect from April 1, 2016 on account of the limitations of the Base Rate regime. With the introduction of the MCLR system, it was expected that the existing Base Rate linked credit exposures shall also migrate to MCLR system.

It is observed, however, that a large proportion of bank loans continue to be linked to the Base Rate despite the Reserve Bank highlighting this concern in earlier monetary policy statements. “Since MCLR is more sensitive to policy rate signals, it has been decided to harmonise the methodology of determining benchmark rates by linking the Base Rate to the MCLR with effect from April 1, 2018. Necessary instructions will be issued by the end of next week,” said the RBI in its sixth monetary policy on Wednesday.

VS Parthasarathy, Group Chief Financial Officer & Group CIO, Mahindra & Mahindra said, “The RBI’s re-tooling of MCLR is good news for the corporate sector as it will become transparent for rate transmission.”