To stay relevant in the competitive market, commercial banks used unfair practices for lending money. Ultimately, borrowers want the best deal with the lowest interest rate for higher amounts. In the recent past, the nation's monetary body, the Reserve Bank of India (RBI), has taken some unexpected measures regarding the loan lending rates & its policies. Thus, the measures were compulsory because the fluctuating interest rates of commercial banks were affecting the borrowers and directly or indirectly the country's economy. For this, RBI introduced PLR, MCLR and revised Repo rates to fix those issues & maintain a transparent financial system. So, let's look at them each in detail.
The Prime Lending Rate (PLR) or Prime Rate is the interest rate at which the banks lend money
to their creditworthy customers.
RBI introduced the Benchmark Prime Lending Rates (BPLR) in 2003 for ensuring the appropriate
loan pricing & transparency in the system.
As of 2022, India's highest prime rate is 8.80, and it fluctuates between 6.60% to 8.90%,
following the individual banks.
a.Significance of PLR
The PLR acts as a reference point for other interest rates such as mortgages, automobile
loans, credit cards & more.
The prime rate also affects the financial liquidity in the market, and both have an inverse
proportionality ratio with each other. If the Prime Lending Rate is decreased, the liquidity
is increased & hence easier, meaning the loans becomes affordable & easier to access.
b. How to calculate PLR
The Prime Lending rate is broadly affected by Federal Funds Target Rate or fed funds. The
prime rate is fed funds + 3%, meaning if the Federal Funds Target Rate is 2%, then the prime
rate will be 5%.
MCLR is the Marginal Cost of Funds Based by Lending Rates was introduced in the Indian
financial system by RBI in 2016.
MCLR is the minimum interest rate at which banks aren't permitted to lend the loan; however,
it is not applicable in some exceptional cases. MCLR is the internal reference to the banks
for determining their interest rates on loans.
a.Significance of MCLR
Since MCLR replaced the base rate from the Indian monetary system, the banks' prime
customers couldn't take undue advantage.
The MCLR depends upon the repo rate issued by the RBI & due to the MCLR implementation, the
interest rates involves a lot of respective risks for the individual borrowers.
b. How to calculate MCLR
Banks calculate MCLR based on loan tenor meaning the period that a borrower will take to
repay the loan along with interest. Generally, the loan amount & the tenor have a
proportionality ratio.
For calculating the exact lending rates, the banks consider the following:
• Tenor
• The marginal fund's cost
• Operating costs
• Negative Carry on the CRR (Cash Reserve Ratio)
Given below are one-year MCLR rates for popular banks such as:
HDFC: 7.20%
ICICI: 7.25%
AXIS: 7.40%
SBI: 7.00%
Repo rate is the interest rate at which the nation's financial body, the Reserve Bank of
India (RBI), lends money to the commercial banks when the commercial banks are short of
funds.
The repo rate is decided by the Monitory Policy Committee (MPC) of RBI, and as of February
2022, the repo rate is 4%.\
a.Significance of Repo rate
The repo rate is a powerful tool to control cash liquidity and money supply.
In addition, the repo rate is a robust solution for controlling inflation. The MPC increase
in the repo rate prevents the commercial banks from lending money from the RBI, and this
docks off the money supply in the market & hence no inflation.
b. How to calculate Repo rate
The MPC of RBI calculates the Repo rate based on inflation & recession in the market.
c. Difference between repo rate & reverse repo rate
The Reverse repo rate is the interest the RBI pays to the commercial banks when the
commercial banks deposit additional funds in the Central bank treasury.
The repo rate is always higher than the reverse repo rate to keep an eye on inflation.
Meanwhile, the reverse repo rate is used for measuring the overall money supply in the
economy. As of February 2022, the reverse repo rate is 3.35%.
Here is a table for a quick comparison of PLR, MCLR and repo rates based on equal grounds.
