Banks look to shift focus to MCLR-linked loans ahead of rate cuts to protect margins

In anticipation of the beginning of a softer rate cycle, several banks are looking to raise the share of their marginal cost-based lending rate (MCLR)-linked loans to prevent their net interest margin from falling sharply, according to industry executives.

Loans linked to the external benchmark like repo rate will start earning less the moment the Reserve Bank of India (RBI) cuts the policy repo rate, or the rate at which the RBI lends money to commercial banks, as the transmission to those loans happens automatically.

The central bank’s monetary policy committee is widely expected to begin the rate easing cycle at its first meeting of the year on Friday with a 25 basis point repo rate cut.

A basis point is a hundredth of a percentage point.

Bank of India, Indian Bank and Indian Overseas Bank have spoken about their intention to raise MCLR-linked lending in a bid to protect their margin.

“We have decided to focus on increasing the MCLR-linked portfolio. The entire corporate portfolio is MCLR-linked and this would be the area to focus to compensate for the impact of repo rate cuts,” said Indian Overseas Bank managing director Ajay Kumar Srivastava.The bank is planning to raise the share of MCLR-linked loans to 50-55% by the end of FY26 from about 45% at present, he said. Bank of India managing director Rajneesh Karnatak recently spoke on similar lines. The bank increased its one-year MCLR rate to 9.05% from 8.40% as of January 2023, when the central bank raised the repo rate to 6.50%. After that, the RBI maintained a status quo.

Bank of India’s repo-linked rate was fixed at 9.35%.

The concept of external benchmark linked rate (EBLR) was introduced to make the transmission of rate cuts quicker. Before EBLR, there was a common refrain among borrowers that banks took time to transmit the rate cuts by the RBI. Although banks keep repo-linked rates higher than MCLR-linked rates, the repo-linked rate comes down faster when monetary easing happens.

“We would try to shift customers from the EBLR-linked rates to MCLR-linked rates to minimise the impact of any policy rate reduction. This needs to be done in such a way so that we don’t lose customers,” said Indian Bank managing director Binod Kumar.

Some bank executives, however, believe that tweaking such a lending strategy could just be a short- term measure.

“Protecting net interest margin would depend on many other factors such as the ability to mobilise low-cost deposits and improving customer service and controlling other operating expenses,” said Canara Bank managing director K Satyanarayana Raju. “Raising low-cost deposits is the major challenge at present.”