Marginal cost of funds based lending rate to increase in FY24

Commercial will increase the marginal cost of funds based lending rate MCLR by 100-150 basis points bp in the next financial year FY 24 due to a rise in the cost of money and tight liquidity. The transmission of monetary policy in the banking system could intensify in FY 24 according to India Ratings and Research Ind-Ra, as a result of the repo rate rising since May 2022, the median MCLR of one-year duration has gone up by 120 basis points between May 2022 and February 2023, according to Reserve Bank of India RBI data. The policy repo rate was raised by 250 basis points in stages to 6.5 per cent in February 2023.

MCLR-linked loans are mostly given to corporate and business establishments. According to data, these loans had 46.5 per cent of outstanding floating rate rupee loans as of September 2022.

In FY 23 the drawdown by reverse repo was to the tune of five trillion, according to Ind-Ra. This has allowed banks to address a surge in the gap between incremental credit and deposit, and will not be available in FY 24. MCLR will show a significant rise.

A tepid balance of payments BoP surplus of around 600 billion won't bring any improvement to the aggregate deposit, the agency said. Even if the policy rate remains stable for FY 24, rates in the banking system will continue to face upward pressure.

There are multiple factors that could cause system liquidity to tighten in the coming two to three weeks of March 2023, such as advance tax payment, GST payment and TLTRO maturity. With the onset of the year ending, the activity in the banking system is expected to accelerate, especially on account of credit offtake.

The presence of required system liquidity is a priority for the support of the system. Tools and mechanisms could be used to vary between the long-term repo auction and open market purchase of short-term bonds or T-bills. It added that the upcoming period of tight liquidity could be difficult for entities with a weak liquidity profile.

The incremental funding is happening at higher costs. The RBI's drawdown of cash flow with the RBI has supported the impact of marginal cost of funding, as the large part of the credit disbursement has so far been limited. In FY 24 the incremental funding by banks would have to be made by fresh deposits, so the marginal cost of funding will go up significantly.

In the last year, deposits in the banking system have gone up by 150 to 200 bp, which has resulted in a 75 bp increase in aggregate deposits in the system, said Ind-Ra.