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Banks cut their interest rates (Relevant for GS Prelims and Mains paper III)

According to a statement issued by the SBI, its one-year MCLR would be 8 per cent as compared with 8.9 per cent earlier. The rate cut will be applicable to all fresh loans. 
ICICI Bank, the country’s largest private sector lender, has reduced its marginal cost of funds–based lending rate (MCLR) by 70 basis points (bps) across all loan tenures.
Other banks have also reduced their benchmark lending rates.

Reason for slashing interest rates:
Banks have been able to cut interest rates because of large amount of deposits made by people following demonetisation drive by government. Moreover, Government has mandated banks to reduce the interest charges.

What is MCLR?
The Reserve Bank of India has brought a new methodology of setting lending rate by commercial banks under the name Marginal Cost of Funds based Lending Rate (MCLR). It has modified the existing base rate system from April 2016 onwards.

The new methodology requires the banks to charge interest rates based on the additional cost or marginal cost incurred by banks to obtain the funds. This means that the interest rate given by a bank for deposits and the repo rate (for obtaining funds from the RBI) are the decisive factors in the calculation of MCLR.   

Why the MCLR reform?
At present, the banks are slightly slow to change their interest rate in accordance with interest rate change by the RBI. Commercial banks are significantly depending upon the RBI’s repo to get short term funds. But they are reluctant to change their individual lending rates and deposit rates with periodic changes in repo rate.

Whenever the RBI is changing the repo rate, it was verbally compelling banks to make changes in their lending rate. The purpose of changing the repo is realized only if the banks are changing their individual lending and deposit rates.



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