Marginal cost is the cost added by producing one extra item of the product. In banking we can say that marginal cost of fund is the cost of acquiring additional deposits and additional borrowing.
You may say that it is the incremental cost of fund, it is cost of borrowing more money to fund additional asset purchases or investments.
In its simplest calculation, the marginal cost of funds is simply the interest rate on the new loan balance.
Marginal cost of funds is entirely different with the average cost of funds,
Average cost of fund is decided by dividing total fund mobilized by deposits by total interest paid which would be calculated by computing a weighted-average of all the combined loans' interest rates
Marginal cost of fund based lending Rates (MCLR) has to be revised by every bank every month. They have to fix it for different time periods ranging from overnight (One day) to one year.
Now it is mandatory for banks to consider the repo rate while calculating their MCLR. RBI says that effective passing of repo rate change into interest rate change by the banking system as an important part of monetary transmission.
The concept of marginal is important to understand MCLR
While calculating the lending rates, banks have to consider the changed cost conditions or the marginal cost conditions.
For bank, what are the costs for obtaining fund?
It is basically rate given to the depositors
As per new guidelines issued by RBI lending rates have to be decided by each bank based on its marginal cost of fund.
1. Marginal cost of fund which depends on Marginal cost of deposits, and marginal cost of borrowing
2. it depends on negative cost of CRR
3. it depends on operational cost
4. And Tenor of loan
HOW MCLR is different from Base Rate?
The base rate is calculated based on following factors
- Cost for the funds (interest rate given for deposits)
- Operating expenses
- Minimum rate of return (profit) and
- Cost for the CRR
It is clear that the CRR cost and operating expenses are the common factors for both Base Rate and the MCLR.
The factor Minimum rate of return is explicitly excluded under MCLR
But the most important difference is the careful calculation of Marginal cost under MCLR
On the other hand under base rate, the cost is calculated on an average basis by simply averaging the interest rate incurred for deposits.
Then the requirement that MCLR should be revised monthly makes the MCLR very dynamic compared to base rate.
Some experts in economics feel that low interest rate will help in growth of economy. They feel that if interest rates are high economy will not grow.
RBI and Government of India both are therefore borrower friendly. They think that if borrowers are given loan at lower rate of interest, they will invest their own capital and encouraged to do more and more business. It is assumed that Indian Corporate makes new projects if interest rate is lower. Lower interest rate will induce and motivate business men to borrow.
Suppose I need a house of Rs.20 lac ,
If the rate of interest is 10% EMI will be Rs.19300/
If the ROI is 9.9% EMI will be 19168
(Difference is Rs.122/ only)
If the ROI is 9.5% EMI is Rs.18643
If ROI is 9% EMI will be Rs.18000
But it is not fully true to say that lowering of the interest rate will prompt business men to opt for more and more loan and induce service men to avail more and more consumer or personal loan. If we accept this logic, we may ask for interest free loan too. If no interest is charged, then as per said logic maximum number of businessmen will come forward to avail loan .
Bitter truth is that a service man opt for a home loan of Rs.20.00 lac only when he or she is able to pay monthly EMI of Rs.19000/. If an individual can afford saving Rs.19000 for Home Loan EMI , he or she can spare Rs.19500 or Rs.20000 too. (He already gets Income tax relief if he takes Home loan) , he does not bother much if interest rate is increased by 1 or 2 percent)
If a businessman finds a business profitable and his products are saleable easily in the market , then only he decides to do a business and he become ready paying a little bit more interest . Businessmen first try to keep his capital safe and protected and then think for profit and lastly he will think for a little bit higher profit by paying a little bit lower interest rate on credit he enjoys.
On the other hand a retired person whose livelihood depends on interest income he will have to face difficult days only to help rich borrowers. If a retired person after working for three to four decades in a company or in government offices gets terminal benefit of say Rs.20.00 lac, he keeps it in Fixed deposit of a bank and withdraw monthly interest of Rs.15000 @9% p.m. to spend for family. If bank reduces interest from 9% to 8 % he gets only Rs.13333 per month to spend for his family. It means his spending capacity is reduced by 11%.
If again rate payable on fixed deposit is reduced to 7% he is left with only Rs.11666/ per month. Thus reducing interest rate by one more percent, his monthly income is reduced by 22%. Further if he has to pay income tax on interest income, his position become more miserable.
In this way we may say that by lowering interest rate on deposits , Government of India is directly hurting family of retired persons and old aged families . If we keep price rise and inflation in mind, we may imagine the level of torturous treatement GOI gives to old aged retired person by forcing low rate regime to banks. Lowering of interest rate hurts to all families who depend on interest income and number of such families is significant and considerably higher. GOI should and cannot therefore ignore their interest income only to make credit cheaper.
Here I like to add ,that a business man has to pay interest of Rs.12 lac to bank if it avails a loan of Rs.1 crore for doing business at the rate of 12% p.a.. If banks reduces lending rate from 12% to 11% , the business man saves Rs.1 lac in a year.
A business man who avails a loan of Rs.1 crore from bank , usually make a turnover of at least Rs.5 crore . If we reduce from total sale value RS 0.50 crore as profit margin,,cost of product will be 4.5 crore. If interest rate falls by 1 percent, cost of production will rise from Rs 4.50 crore to Rs.4.51 crore or profit margin of borrower will come down from Rs.0.50 lac to RS.0.49 lac.
As such lowering of interest rate by one percent and by saving of one lac per year does not affect much the product cost or profitability of the businessmen. Fact is that the borrower does not cut in his profit but pass the burden of interest wholly on product cost and ultimately it is again the consumer who has to bear the load, though the rise in price of product due to rise in interest is too insignificant in comparision to usual price.
If again rate payable on fixed deposit is reduced to 7% he is left with only Rs.11666/ per month. Thus reducing interest rate by one more percent, his monthly income is reduced by 22%. Further if he has to pay income tax on interest income, his position become more miserable.
In this way we may say that by lowering interest rate on deposits , Government of India is directly hurting family of retired persons and old aged families . If we keep price rise and inflation in mind, we may imagine the level of torturous treatement GOI gives to old aged retired person by forcing low rate regime to banks. Lowering of interest rate hurts to all families who depend on interest income and number of such families is significant and considerably higher. GOI should and cannot therefore ignore their interest income only to make credit cheaper.
Here I like to add ,that a business man has to pay interest of Rs.12 lac to bank if it avails a loan of Rs.1 crore for doing business at the rate of 12% p.a.. If banks reduces lending rate from 12% to 11% , the business man saves Rs.1 lac in a year.
A business man who avails a loan of Rs.1 crore from bank , usually make a turnover of at least Rs.5 crore . If we reduce from total sale value RS 0.50 crore as profit margin,,cost of product will be 4.5 crore. If interest rate falls by 1 percent, cost of production will rise from Rs 4.50 crore to Rs.4.51 crore or profit margin of borrower will come down from Rs.0.50 lac to RS.0.49 lac.
As such lowering of interest rate by one percent and by saving of one lac per year does not affect much the product cost or profitability of the businessmen. Fact is that the borrower does not cut in his profit but pass the burden of interest wholly on product cost and ultimately it is again the consumer who has to bear the load, though the rise in price of product due to rise in interest is too insignificant in comparision to usual price.
Now if we consider the position of banks, it is not easy for banks to lower interest rate as and when RBI reduces repo rate in the same proportion in which RBI reduces repo rate.Banks will have to reduce interest rate on deposits to lower lending rate.
As we have seen above , how MCLR is calculated and how it is dependent on four factors in which repo rate fluctuation is one factor. Here it is important to point out that fund acquired for lending by a bank is primarily and mainly contributed by deposit it acquires from public and borrowings it avails from RBI at repo rate. Out of total fund a bank acquires , it is hardly 10% of it , which is acquired by borrowing from lending from RBI. It means if a bank has got a fund of one lac crore for lending it is hardly Rs.10000 crore which is borrowed at repo rate from RBI.
If average cost of deposit is say 7% cost of Rs.90000 core comes to Rs.6300 crore and if repo rate is 6.5% , cost of Rs.10000 crore borrowing at repo rate will be Rs.650 crore . It means total cost of fund of Rs.100000 crore will be Rs.6950 crore. Here I would like to make it clear that average cost of fund for bank is almost same as current Repo Rate.
Suppose , that the bank do not avail borrowing facility at repo rate from RBI and gets entire fund of Rs.100000 crore from public deposits only , the total cost of fund would have been Rs.7000 crore . In this way we may say that bank in practice saves only Rs.50 crore on a total corpus of Rs.100000 crore. Therefore while calculating MCLR for lending , bank can at best give a relief of Rs.50 crore on total lending of Rs. 100000 crore done by the bank assuming other factors as constant. It means banks can hardly reduce MCLR by 0.05 %.
Unfortunately RBI, GOI and mediamen do not understand this mathematics and they confuse consumers by frequently sending a wrong message in public domain that banks are not transmitting impact of repo cut fully in lending rate and thus change in monetary policy announced by RBI do not get transmitted to people of India.
Very often, it is also seen that Chiefs of various banks cut their lending rate just to please ministers, to get elevation in personal career and to please Governor of RBI . It adversely affects the profitability of banks . It is seen many times in the past that under pressure of FM Mr. Chidambram , some banks used to cut base rate same day when FM used to announce cut in Repo rate without even undertaking excercise of calculation of base rate.
Very often, it is also seen that Chiefs of various banks cut their lending rate just to please ministers, to get elevation in personal career and to please Governor of RBI . It adversely affects the profitability of banks . It is seen many times in the past that under pressure of FM Mr. Chidambram , some banks used to cut base rate same day when FM used to announce cut in Repo rate without even undertaking excercise of calculation of base rate.
If RBI Governor and GOI continue to build pressure on banks to cut interest rate on lending, Chiefs of Banks will succumb to pressure and reduce MCLR. But there is no doubt that it will affect their net interest margin and it will badly affect their survival and thier capacity of lending if volume of stressed assets continue to rise.
To add fue to fire, banks will not be able to mobilise deposits due to continuous fall in deposit rates. Depsoit growth last year was lowest in last fifty years. and it will furhter fall if banks continue to cur deposit rates. Banks, RBI and GOI should at least learn lesson from downtrend in deposits mobilised by a bank and that in credit offtake .
To add fue to fire, banks will not be able to mobilise deposits due to continuous fall in deposit rates. Depsoit growth last year was lowest in last fifty years. and it will furhter fall if banks continue to cur deposit rates. Banks, RBI and GOI should at least learn lesson from downtrend in deposits mobilised by a bank and that in credit offtake .
It will affect their deposit base and hence reduce their capacity to lend, It will create liquidity problem for banks.
People will start investing and keeping money in NBCC or in gold, or in equity or mutual fund.
Keeping money in NBFC is unsafe, keeping money in gold is inherent risk of getting cheated, it increases gold export then in affected trade deficit
Equity and mutual funds are not safe. Investment in land also indirectly affects land value, production cost etc.
It will reduce saving habit and when savings shrinks , capacity of banks to lend will also shrink. Without deposits, banks cannot undertake lending work. Credit growth which used to 25to 30 % ten years ago has been confined to less than 10% during last financial year.
Banks cannot reduce lending rate also because of rising bad debts.
Furhter , operational cost rises every quarter due to rise in wages and other expenses .
In addition, cost of deposits already accepted on higher rate cannot be reduced when lending rates are lowered. This results in loss to bank. AS per RBI guidelines , banks has to opt for Magrinal Cost of fund based lending rates. If means rate of interest on all floating loans will be reduced as and when MCLR gets reduced , but banks cannnot reduce rate of interest payable on deposits accepted for say ten years or five years. In the long run , banks will suffer a lot in its profitability , if MCLR rate is put in effect in true spirit by banks.
Cost of long term deposits is higher but helps banks in investing and financing for long term projects. For long term investment, we need long term resources like Fixed Deposits. But unfortunately banks prefer paying higher rate of interest on short term deposits and lesser interest on long term deposits. Due to this short term approach , banks may acquire short term deposits in larger volume and long term deposits in lesser volume, but they cannot protect banks.
But while undertaking lending activity, banks prefer long term project lending to achieve higher credit growth in shortest period and in minimum effort. Due to this , they approach high value corporate who can approach banks for loans in thousands of crore of rupees payable in ten years and more.
Now even home loans and education loans are sanctioned by banks for 15 to 30 years tenure as per advice of RBI and GOI.
Impact of this borrower frindly and boss friendly attitude of bank officials, mismatch in asset and liability is increasing, liquidity problem is increasing and finally need of borrowing by banks from other sources like bond market or repo rate borrowing is gradually increasing.
Moreover Small savers are the backbone of our savings. With no social security net, small savers rely on such guaranteed returns. It is therefore unjustifed and unethical on the part of Government to punish savers by paying them lower interest and extending all benefits to borrowers who borrow money from banks.
C Rangarajan , a key economic adviser to PM MMS had said in the past that the government should consider imposing higher than the current rate of 30% on substantially higher income. We must debate unconventional ideas. Fiscal deficit cannot be contained only by curbing expenditure along. We must raise revenue as well.
We have to administer existing taxes better to increase tax collection and stop interfering in business of banks. If GOI wants that banks should strictly follow their dictates, they should merge all PSU banks to make one unified entity and then make a comprehensive policy covering all aspects of banks which will be executed by all banks without any discrimination and without extension of unethical and avoidable concessions to customers in snatching business from other banks.
Finally, I may conclude here that the only way to get the economy to move ahead is not by slashing rates or by curring repo rate or by forcing banks to cut rates on deposits and advances.
We can rather improve environment for credit groowth and GDP growth by making our bureaucracy borrower friendly . We can help in GDP growth by ensuring that the capital locked up in older projects starts paying dividends. Indian corporates who lined up aggressive expansion plans post the financial crisis have already burnt their fingers.Court intervention, policy uncertainty and lack of access to natural resources, energy and in some cases land have stalled many large projects in core sector. We may provide land, coal,power,and good infrastructure to business houses and protect them from political exploitation. And so on.....
Similarly GOI can help banks in recovery of their money from loan defaulters by making legal course of actions easy, quicker and effective. GOI can help banks in getting real credit growth by stoping political pressure on abnks for achieving unachivable targets imposed on them.
It is unlikely that these companies will rush to put up new capacities just because lending rates are lowered by a few percentage points.
If government gets real success in making legal and administrative machinery friendly and hassle free for borrower, bankers and businessmen , I have no doubt that businessm man will not bother even if interest rate on loan they get from banks rises by a few percentage .
Lastly after reading my views mentioned above, I put some question before you
Can Banks Cut Lending Rate ?
Is Lowering Of Interest Rate Good For Banks
Is curring interest rate good for Savers ?
Can bank fully depend on borrowing at rapo rate from RBI ?
Is RBI justified in regulating and pressurising banks to lower rates?
Will lowering of rates help in credit growth and GDP growth?
Can banks remain profitable and serve poor better by lowering rates?
Can bank achieve higher credit growth only by lowering rates?
Can cut in Repo Rate play a bigger role in credit growth?
Is RBI justified in regulating and pressurising banks to lower rates?
Will lowering of rates help in credit growth and GDP growth?
Can banks remain profitable and serve poor better by lowering rates?
Can bank achieve higher credit growth only by lowering rates?
Can cut in Repo Rate play a bigger role in credit growth?
No comments:
Post a Comment