Demystifying the New Method to Calculate Lending Rates

By | December 26, 2015

The Marginal Cost of Funds based Lending Rate

If you’ve kept up with the news, you might have heard that the Reserve Bank of India has introduced a new method of calculating bank lending rates. It’s called the Marginal Cost of Funds based Lending Rate.

We lost you there, right? We’ll break it up for you.

Out with the old, in with the new

What was the old method?

The Marginal Cost of Funds based Lending Rate method of calculating lending rates will replace the present base rate system.

How did the Base Rate System work?

With the base rate system, it was the banks that decided what cost it used, to decide the lending rates. This was usually the average cost of funds.

And the new method is different, how?

The new Marginal Cost of Funds based Lending Rate method requires banks to calculate the lending rate by considering the marginal cost of funds.

Benefits of the New Method

• The Marginal Cost of Funds based Lending Rate method will ensure the ready availability of bank credit at interest rates that are fair to both borrowers and the banks.
• This method will be a more uniform way of calculation that will help borrowers to benefit from lower interest rates.
• With the new method, the process of fixing the interest rates on loans will be more transparent.

The Marginal Cost of Funds based Lending Rates on various maturities will be announced by the banks every month on a pre-fixed date.

What will be included in the new method of calculation?

The RBI has recommended that those loans that charge a fixed rate of interest in initial years, followed by floating rates in later years will be priced according to the Marginal Cost of Funds based Lending Rate method.

What will not be included in the new method of calculation?

All fixed rate loans, read Personal Loans and Auto Loans will not be calculated based on the Marginal Cost of Funds based Lending Rate method.

Any special exclusions in this new method of calculation

Similar to how it was with the base rate system, banks will not be permitted to lend below the Marginal Cost of Funds based Lending Rate. There are a few exceptions to this rule though. These are loan categories such as loans against deposits and loans to banks’ own employees.

When does the Marginal Cost of Funds based Lending Rate come into effect?

The new method of loan rate calculation will take effect on 1 April 2016.

That’s everything you need to know about the new lending rate calculation method.

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Category: Loans