Core banking is a banking service provided by a group of networked bank branches where customers may

access their bank account and perform basic transactions from any of the member branch offices.
Core banking is often associated with retail banking and many banks treat the retail customers as their
core banking customers. Businesses are usually managed via the Corporate banking division of the
institution. Core banking covers basic depositing and lending of money.
Normal Core Banking functions will include transaction accounts, loans, mortgages and payments. Banks
make these services available across multiple channels like ATMs, Internet banking, mobile banking and
branches.[1]
The core banking services rely heavily on computer and network technology to allow a bank to centralise
its record keeping and allow access from any location. It has been the development of banking
software that has allowed core banking solutions to be developed.
History
Core banking became possible with the advent of computer and telecommunication technology that
allowed information to be shared between bank branches quickly and efficiently.
Before the 1970s it used to take at least a day for a transaction to reflect in the account because each
branch had their local servers, and the data from the server in each branch was sent in a batch to the
servers in the data center only at the end of the day (EoD).
Over the following 30 years most banks moved to core banking applications to support their operations
where CORE Banking may stand for "centralized online real-time exchange". This basically meant that
all the bank's branches could access applications from centralized data centers. This meant that the
deposits made were reflected immediately on the bank's servers and the customer could withdraw the
deposited money from any of the bank's branches.
Software solution
Core banking solutions is jargon used in banking circles. The advancement in technology, especially
Internet and information technology has led to new ways of doing business in banking. These
technologies have reduced manual work in banks and increasing efficiency. The platform where
communication technology and information technology are merged to suit core needs of banking is
known as core banking solutions. Here, computer software is developed to perform core operations of
banking like recording of transactions, passbook maintenance, interest calculations on loans and deposits,
customer records, balance of payments and withdrawal. This software is installed at different branches of
bank and then interconnected by means of computer networks based on telephones, satellite and
the internet. It allows the banks customers to operate accounts from any branch if it has installed core
banking solutions.
Gartner defines a core banking system as a back-end system that processes daily banking transactions,
and posts updates to accounts and other financial records. Core banking systems typically include deposit,
loan and credit-processing capabilities, with interfaces to general ledger systems and reporting tools. Core
banking applications are often one of the largest single expense for banks and legacy software are a major
issue in terms of allocating resources. Strategic spending on these systems is based on a combination of
service-oriented architecture and supporting technologies that create extensible architectures.
Many banks implement custom applications for core banking. Others implement/customize
commercial ISV packages.
While many banks run core banking in-house, there are some which use outsourced service providers as
well.
There
are
several
Systems
integrators
like
Cognizant, EdgeVerve
Systems
Limited, Capgemini, Accenture, IBM and TCS which implement these core banking packages at banks.

The Reserve Bank announced the constitution of the Working Group on Benchmark Prime Lending Rate
(BPLR) in the Annual Policy Statement of 2009-10 (Chairman: Shri Deepak Mohanty) to review the
BPLR system and suggest changes to make credit pricing more transparent.
The Working Group was assigned the following terms of reference
(i)
to review the concept of BPLR and the manner of its computation;
(ii)
(ii) to examine the extent of sub-BPLR lending and the reasons thereof;
(iii)
(iii) to examine the wide divergence in BPLRs of major banks;
(iv)
(iv) to suggest an appropriate loan pricing system for banks based on international best
practices;
(v)
(v) to review the administered lending rates for small loans up to Rs 2 lakh and for exporters;
(vi)
(vi) to suggest suitable benchmarks for floating rate loans in the retail segment; and
(vii)
(vii) consider any other issue relating to lending rates of banks.
What were the main recommendations of the BPLR group ?
The main recommendations of the Group were

After carefully examining the various possible options, views of various stakeholders from
industry associations and those received from the public, and international best practices, the Group is of
the view that there is merit in introducing a system of Base Rate to replace the existing BPLR system.

The proposed Base Rate will include all those cost elements which can be clearly identified and
are common across borrowers. The constituents of the Base Rate would include (i) the card interest rate
on retail deposit (deposits below Rs. 15 lakh) with one year maturity (adjusted for CASA deposits); (ii)
adjustment for the negative carry in respect of CRR and SLR; (iii) unallocatable overhead cost for banks
which would comprise a minimum set of overhead cost elements; and (iv) average return on net worth.

The actual lending rates charged to borrowers would be the Base Rate plus borrower-specific
charges, which will include product-specific operating costs, credit risk premium and tenor premium.

The Working Group has worked out an illustrative methodology for computing the base rate for
the banks. According to this methodology with representative data for the year 2008-09, the illustrative
Base
Rate
works
out
to
8.55
per
cent.

With the proposed system of Base Rate, there will not be a need for banks to lend below the Base
Rate as the Base Rate represents the bare minimum rate below which it will not be viable for the banks to
lend. The Group, however, also recognises certain situations when lending below the Base Rate may be
necessitated by market conditions. This may occur when there is a large surplus liquidity in the system
and banks instead of deploying funds in the LAF window of the Reserve Bank may prefer to lend at rates
lower than their respective Base Rates. The Group is of the view that the need for such lending may arise
as an exception only for very short-term periods. Accordingly, the Base Rate system recommended by the
Group will be applicable for loans with maturity of one year and above (including all working capital
loans).

Banks may give loans below one year at fixed or floating rates without reference to the Base
Rate. However, in order to ensure that sub-Base Rate lending does not proliferate, the Group recommends
that such sub-Base Rate lending in both the priority and non-priority sectors in any financial year should
not exceed 15 per cent of the incremental lending during the financial year. Of this, non-priority sector
sub-Base Rate lending should not exceed 5 per cent. That is, the overall sub-Base Rate lending during a
financial year should not exceed 15 per cent of their incremental lending, and banks will be free to extend
entire sub-Base Rate lending of up to 15 per cent to the priority sector.

At present, at least ten categories of loans can be priced without reference to BPLR. The Group
recommends that such categories of loans may be linked to the Base Rate except interest rates on (a)
loans relating to selective credit control, (b) credit card receivables (c) loans to banks own employees;
and (d) loans under DRI scheme.

The Base Rate could also serve as the reference benchmark rate for floating rate loan products,
from
the
other
external
market
benchmark
rates.

apart

In order to increase the flow of credit to small borrowers, administered lending rate for loans up
to Rs. 2 lakh may be deregulated as the experience reveals that lending rate regulation has dampened the
flow of credit to small borrowers and has imparted downward inflexibility to the BPLRs. Banks should
be free to lend to small borrowers at fixed or floating rates, which would include the Base Rate and
sector-specific operating cost, credit risk premium and tenor premium as in the case of other borrowers.

The interest rate on rupee export credit should not exceed the Base Rate of individual banks. As
export credit is of short-term in nature and exporters are generally wholesale borrowers, there is need to
incentivise export credit for exporters to be globally competitive. By this change in stipulation of pricing
of export credit, exporters can still access rupee export credit at lower rates as the Base Rate envisaged is
expected to be significantly lower than the BPLRs. The Base Rate based on the methodology suggested
by the Group is comparable with the present lending rate of 9.5 per cent charged by the banks to most
exporters. The proposed system will also be more flexible and competitive.

At present the interest rates on education loans are linked to ceilings with reference to the BPLR.
In view of the critical role played by education loans in developing human resource skills, the interest rate
on these loans may continue be administered. However, in view of the fact that the Base Rate is expected
to be significantly lower than BPLR, the Group recommends that there is a need to change the mark up.
Accordingly, the Group recommends that the interest rates on all education loans may not exceed the
average Base Rate of five largest banks plus 200 basis points. Even with this stipulation, the actual
lending rates for education loans would be lower than the current rates prevailing. The information on the
average Base Rate should be disseminated by IBA on a quarterly basis to enable banks to price their
education
loan
portfolio.

In order to bring about greater transparency in loan pricing, the banks should continue to provide
the information on lending rates to the Reserve Bank and disseminate information on the Base Rate. In
addition, banks should also provide information on the actual minimum and maximum interest rates
charged
to
borrowers.

All banks should follow the Banking Codes and Standards Board of India (BCSBI) Codes for fair
treatment of customers of banks, viz., the Code of Banks Commitment to Customers (Code) and the
Code of Banks Commitment to Micro and Small Enterprises (MSE Code) scrupulously. The Group also
recommends that the Reserve Bank may require banks to publish summary information relating to the
number of complaints and compliance with the codes in their annual reports
From BPLR to Base rate to MCLR :: What is new thing named MCLR ?
The Indian banking sector has struggled through a number of rate-setting methods over the last few years
and has moved from a benchmark prime lending rate (BPLR) system to a base rate (or minimum lending
rate) system and now the marginal cost of funds-based lending rate (MCLR).
The Reserve Bank of India has brought a new methodology of setting lending rate by commercial banks
under the name Marginal Cost of Funds based Lending Rate (MCLR). It will replace the existing base
rate system from April 2016 onwards.

According to the new rules, every bank will be required to calculate its marginal cost of funds across
different tenors. To this, the banks will add other components including operating cost and a tenor
premium.

Why the MCLR reform?

At present, the banks are slightly slow to change their interest rate in accordance with repo rate
change by the RBI.
Commercial banks are significantly depending upon the RBIs LAF repo to get short term funds.

But they are reluctant to change their individual lending rates and deposit rates with periodic
changes in repo rate.

Whenever the RBI is changing the repo rate, it was verbally compelling banks to make changes in
their lending rate.

The purpose of changing the repo is realized only if the banks are changing their individual
lending and deposit rates.
Implication on monetary policy

Now, the novel element of the MCLR system is that it facilitates the so called monetary
transmission. It is mandatory for banks to consider the repo rate while calculating their MCLR.

Previously under the base rate system, banks were changing the base rate, only
occasionally. They waited for long time or waited for large repo cuts to bring corresponding reduction
in their base rate.

Now with MCLR, banks are obliged to readjust interest rate monthly. This means that such quick
revision will encourage them to consider the repo rate changes.
How to calculate MCLR ?

The concept of marginal is important to understand MCLR.

In economics sense, marginal means the additional or changed situation. While calculating the lending
rate, banks have to consider the changed cost conditions or the marginal cost conditions.
For banks, what are the costs for obtaining funds? It is basically the interest rate given to the depositors
(often referred as cost for the funds). The MCLR norm describes different components of marginal costs.
A novel factor is the inclusion of interest rate given to the RBI for getting short term funds the repo rate
in the calculation of lending rate.

Following are the main components of MCLR.

1.

Marginal cost of funds;

2.

Negative carry on account of CRR;

3.

Operating costs;

4.

Tenor premium.

What are these components ?

Marginal Cost: The marginal cost that is the novel element of the MCLR. The marginal cost of
funds will comprise of Marginal cost of borrowings and return on networth. According to the RBI, the
Marginal Cost should be charged on the basis of following factors:
1. Interest rate given for various types of deposits- savings, current, term deposit, foreign currency
deposit
2. Borrowings Short term interest rate or the Repo rate etc., Long term rupee borrowing rate
3.

Return on networth in accordance with capital adequacy norms.

Negative carry on account of CRR: is the cost that the banks have to incur while keeping reserves
with the RBI. The RBI is not giving an interest for CRR held by the banks. The cost of such funds kept
idle can be charged from loans given to the people.
Operating cost: is the operating expenses incurred by the banks
Tenor premium: denotes that higher interest can be charged from long term loans (What is it
exactly ? -->> A tenor premium is the compensation for the risk associated with lending for a longer
time.)

The marginal cost of borrowings shall have a weightage of 92% of Marginal Cost of Funds while return
on networth will have the balance weightage of 8%.
Moral of the Story being that in essence, the MCLR is determined largely by the marginal cost for funds
and especially by the deposit rate and by the repo rate. Any change in repo rate brings changes in
marginal cost and hence the MCLR should also be changed.
How MCLR is different from base rate?

So what is common between the two methodologies ?

It is very clear that the CRR costs 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.
Then whats new in it ?

The most important difference is the careful calculation of Marginal costs 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.

The requirement that MCLR should be revised monthly makes the MCLR very dynamic
compared to the base rate.
Under MCLR:

1.

Costs that the bank is incurring to get funds (means deposit) is calculated on a marginal basis

2.

The marginal costs include Repo rate; whereas this was not included under the base rate.

3. Many other interest rates usually incurred by banks when mobilizing funds also to be carefully
considered by banks when calculating the costs.
4.

The MCLR should be revised monthly.

5.

A tenor premium or higher interest rate for long term loans should be included.

Advantages ?

With the inclusion of shorter term MCLR rates, banks can compete with the commercial paper
market as well.

moving towards international standards.

will reduce the cost of borrowing for companies.

will make the lending rate framework more dynamic as different banks could have different
MCLRs for different tenures.
Demerits / Disadvantages/Roadbloacks/Shortcomings ?

Banks have been given the option to keep outstanding loans linked to the base rate system even
though it said existing borrowers will also have the option to move to an MCLR linked loan at
mutually acceptable terms."

Most banks are unlikely to offer this option easily as it means that any immediate hit
to profitability may be avoided.

Certain loans such as those extended under government schemes or under restructuring package,
advances to banks depositors against their own deposits, loans to banks own employees including
retired employees and loans linked to a market-determined external benchmark will be exempt from
the MCLR rule.