According to India Ratings and Research (Ind-Ra), commercial banks in India are expected to increase their Marginal Cost of Funds Based Lending Rate (MCLR) by 100-150 basis points (bp) in the next financial year (FY24), due to a rise in the cost of money and tight liquidity.
The Reserve Bank of India (RBI) has increased the policy repo rate by 250 basis points in stages to 6.5 percent in February 2023, leading banks to raise the median MCLR by 120 basis points between May 2022-February 2023, as per RBI data.
MCLR-linked loans are mostly given to corporate and business establishments and had a 46.5 percent share in outstanding floating rate rupee loans as of September 2022, as per RBI data. The tightening of liquidity is likely to intensify the transmission of monetary policy in the banking system in FY24, according to Ind-Ra.
Ind-Ra said that banks’ drawdown from the reverse repo in FY23 was around Rs five trillion, which helped address the surge in the gap between incremental credit and deposit. However, this would not be available in FY24, leading to a significant rise in MCLR.
A tepid balance of payments surplus of around Rs 600 billion would not bring any reasonable improvement in the aggregate deposit. Therefore, even if the policy rate remains stable for FY24, rates in the banking system will continue to face upward pressure.
The system liquidity may tighten further in the coming two to three weeks of March 2023, owing to multiple factors such as advance tax payment, GST payment, and TLTRO maturity. Additionally, with the onset of year-end, the activity in the banking system is expected to accelerate, especially on account of credit offtake. The RBI will remain supportive by ensuring the presence of required system liquidity. However, tools and mechanisms could vary between long-term repo auctions and open market purchases of short-term bonds or T-bills.
The incremental funding is happening at higher costs, and the impact of the marginal cost of funding has so far been limited as the large part of the incremental credit disbursement has been supported by the drawdown of cash flow with the RBI in lieu of reverse repo in FY23. However, in FY24, incremental funding by banks will have to be done by way of fresh deposits, leading to a significant increase in the marginal cost of funding.
Ind-Ra noted that deposit rates in the banking system have shot up by 150 to 200bp in the last year, leading to a 75bp increase in aggregate deposits in the system. The upcoming period of tight liquidity could prove difficult for entities with a weak liquidity profile, it added.
In conclusion, commercial banks in India are expected to increase their MCLR by 100-150bp in FY24, due to a rise in the cost of money and tight liquidity. The RBI will remain supportive by ensuring the presence of required system liquidity, but the tools and mechanisms could vary between long-term repo auctions and open market purchases of short-term bonds or T-bills. The incremental funding in FY24 will have to be done by way of fresh deposits, leading to a significant increase in the marginal cost of funding. The upcoming period of tight liquidity could prove difficult for entities with a weak liquidity profile.
