Reading between the lines: Does commercial bank's hike in MCLR hints a potential rate hike by RBI?

HDFC Bank shares were buzzing on Tuesday after the private sector lender announced a rate hike in its MCLR (Marginal cost of lending rate) by 10 bps. The move was seen as a surprise as it came only a few days after the RBI kept the base interest rates unchanged at 5.25%. The divergence between the country’s largest private sector bank and the central bank's policy warrants a deep dive into their decision-making and outlook about the economy. Also, does the private sector bank’s hike in lending rate hint at a potential rate hike by the central bank? Let's find out.

What prompts banks to raise MCLR?

MCLR or the marginal cost of lending rate is linked to how affordably banks can raise funds to lend. Basically, it is linked to cost of funds. If the banks note that the cost of funding could increase in coming days or months. It could impact their sourcing of low cost capital, mostly fixed and cash deposits. The hike in MCLR indicates bank is struggling to maintain its cost of funds, which could later lead into squeeze in its margin. The hike in MCLR largely impacts corporate segment and working capital products like OD/CC. The retail category of loans like home loan, personal loan, auto loan and MSME loan remain unaffected as they are linked to external benchmark lending rate (EBLR) often tied to repo rate of central bank.

Does this mean that banks foresee hike in repo rate?

There is no straight answer to this question. Many banks preemptively increase the MCLR as they forsee a hike in the interest rate, which could lead to higher interest on deposits. Meaning, the cost of funds could increase. Additionally, banks cannot raise MCLR immediately after the policy rate hike, which leaves them with lower margins for brief period of months before they plan their next hike. To arrest the impact and save on margins,banks preempt the policy move and increase the MCLR.

Past instances when a hike in MCLR led to RBI rate hike?

The central bank repo rate policy changes are largely determined by surrounding economic factors. In the current situation, which is leading us towards an inflationary scenario, hint at a probable hike in interest rates in coming months. RBI also increased the inflation forecast to 5%, further setting the premise for the move.

Previously, in 2018, when the country was going through similar phase of loosing on forex, sharp rise in crude oil prices, firming of bond yields, the private and public sector banks raised their MCLR rates 10-20 bps between March - May 2018. Which was later followed by a rate hike of 25 bps by the RBI in June 2018 policy announcements.

Second time in 2022, during the Russia-Ukraine war, when crude oil prices jumped near to $150 per barrel and inflation hit 6%, many banks increased their MCLR by 5-10 bps in mid-April, prempting the policy stance by the RBI. The central bank took a surprise rate hike on 4 May of 40 bps to control the liquidity in the economy.