Banks may struggle to fully transmit repo rate cuts on high share of MCLR-linked loans – ETCFO-OxBig News Network

Despite the Reserve Bank of India (RBI) cutting the policy repo rate by 25 basis points to 6.25 per cent in February 2025, banks are likely to face hurdles in passing on the benefits of the rate cut due to the significant presence of loans still linked to legacy internal benchmarks such as the marginal cost of funds-based lending rate (MCLR).

According to the RBI’s latest monetary policy report (MPR), about 39.4 per cent of outstanding floating rate loans of scheduled commercial banks (SCBs) were still linked to MCLR and other older benchmarks like the base rate and benchmark prime lending rate, as of end-December 2024. This figure was down slightly from 43.4 per cent in March 2024, but remains substantial enough to hinder the speed and effectiveness of monetary policy transmission.

Public sector banks (PSBs) continue to hold a significant proportion of MCLR-linked loans, which have longer reset periods and adjust lending rates more slowly in response to changes in the repo rate. In contrast, private banks have a higher share of loans linked to external benchmark-based lending rates (EBLR), which are directly influenced by the repo rate and adjust more quickly.

The delay in MCLR adjustments has meant that while the weighted average lending rate (WALR) on outstanding rupee loans dropped by just 7 basis points after the repo rate cut, the WALR on fresh loans actually rose by 8 basis points during the same period. This reflects the continued prominence of MCLR-linked loans in banks’ portfolios.

EBLR push

Although the share of EBLR-linked loans has increased to 60.6 per cent by December 2024 from 56.6 per cent in March 2024, the transition remains incomplete. EBLR-linked loans, which are predominantly found in retail and micro, small and medium enterprise (MSME) segments, are helping improve the pace of monetary transmission, but the legacy burden of MCLR-linked loans continues to be a drag.

The RBI had introduced the MCLR system in 2016 to improve transmission of repo rate changes, and later mandated EBLR from October 2019 for most new floating rate loans in personal and small business segments. Despite these reforms, the pace of transition has been gradual.

While lending rate transmission has shown improvement—particularly during the first half of FY25—competitive pressures among banks have led to a narrowing of spreads, tempering further downward adjustments. Meanwhile, deposit rates have been climbing due to tight liquidity and strong credit demand, adding pressure to banks’ cost structures.

Between May 2022 and January 2025, the cumulative 250-bps rate hike resulted in a 178-bps rise in the 1-year median MCLR and pushed up WALRs on fresh and outstanding loans by 181 bps and 115 bps, respectively. During the same period, weighted average domestic term deposit rates on fresh and outstanding deposits rose by 253 bps and 199 bps, respectively.

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