Visual Credits: Rakesh Mohan
The RBI has introduced MCLR linked loans instead of Base Rate linked loans for all banks – a move that bodes well for borrowers. If you are looking to get a loan, this article will give you useful information and tips on how MCLR will help you with your loan.
Pursuant to the RBI notification on Interest Rate on Advances issued on 17th December 2015, and RBI Master Directions issued on 3rd March 2016, all floating rate rupee facilities sanctioned and renewed w.e.f. 1st April 2016, shall be priced with reference to the Marginal Cost of Funds based Lending Rate (MCLR) in lieu of Base Rate methodology currently followed by the banks.
Why MCLR?
Since January 2015, the RBI has cut rates by 125 basis points. However, banks have reduced their base lending rates by only 60-75 basis points. The RBI has time and again verbally compelled the banks to reduce the rates and pass on the reduction in repo rate benefits to the end user. However, banks have been reluctant to pass on the interest rate cuts to the end customer.
The new MCLR framework aims to significantly improve the transmission of cuts in policy rates to the end-borrowers by mandating banks to set rates based on their marginal cost of funds rather than their average cost of funds.
It may be noted that this change is only for banks and not applicable to Non-banking financial companies (NBFCs).
How Is MCLR Calculated?
|
Existing Methodology – Base Rate |
New Methodology – MCLR |
| Base Rate calculation comprises:
a) Average cost of funds b) Minimum rate of return c) Operating expenses d) Cost of Cash Reserve Ratio (CRR) |
MCLR calculation comprises:
a) Marginal cost of funds b) Tenor premium (A tenor premium is the compensation for the risk associated with lending for a longer period) c) Operating expenses d) Cost of Cost of Cash Reserve Ratio (CRR) |
| It may be noted that c) and d) are same in the calculation methodologies.
Amidst other differences, the most important difference is the calculation adopted for Marginal cost of funds. MCLR includes the repo rate. The latter is not included in the Base Rate when using the average cost of funds calculation. Thus, any reduction in the repo rate will immediately get adopted in the MCLR, which subsequently will be passed on to the end borrower in a falling interest rates scenario. |
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The current MCLR rates are expected to be lower than the existing base rates for a one year tenure. The table below shows the declared MCLR rates for a few banks.
(Rates in %)
| Banks* | Old Base Rate |
MCLR Rate |
|||||
| Overnight | 1-Month | 3-Month | 6-Month | 1-Year | 2-Year | ||
| SBI | 9.30 | 8.95 | 9.05 | 9.10 | 9.15 | 9.20 | 9.30 |
| HDFC Bank | 9.30 | 8.95 | 9.05 | 9.10 | 9.15 | 9.20 | 9.30 |
| ICICI Bank | 9.35 | 9.00 | 9.00 | 9.10 | 9.15 | 9.20 | – |
| Axis Bank | 9.50 | 9.10 | 9.20 | 9.40 | 9.45 | 9.50 | 9.60 |
*Banks have the option of fixing the appropriate MCLR depending upon the loan product
Example:
- If a customer wants to take a floating rate Home Loan from 1stApril 2016, it will be an MCLR linked loan.
- Banks may use the 6-month or 1-year benchmark MCLR for a Home Loan, and the interest rate for that loan will be reset depending upon the benchmark.
- Now, ICICI has decided to use a 1-year benchmark for all its Home Loans.
-So, let’s say a salaried customer avails of a Home Loan of Rs. 75 lakhs on 1st April 2016.
-He will get a pricing of 1-year MCLR + 25 bps – (1-yr MCLR is 9.20% and a credit spread of 0.25% decided by ICICI – effective interest rate of 9.45%
- Going forward, if the RBI reduces its repo rates at any time during the next financial year, the 1-year MCLR will automatically get reduced and the effective interest rate for the customer will fall from one year of the loan availed date i.e., from 1stApril 2017.
Impact on the End-Borrowers
- Type of Loan: Fixed Rate Loans for a tenure > 3 years need not comply with the MCLR Norms. The MCLR norms apply to fixed rate loans with tenure < 3 years and all floating rate loans.
- Existing / New Borrowers:Existing loans linked to the Base Rate may continue till repayment or renewal, as the case may be. Existing borrowers will also have the option to move to the MCLR linked loan at mutually acceptable terms without any foreclosure charges.
- Pricing Benefit: Currently, the MCLR is less than the Base Rate for most of the banks. Going forward, in a falling interest rates scenario, the MCLR methodology will benefit the customers as the reduction in repo rates will reflect on their interest rates.
- However, in an ascending interest rates scenario, the customers will have to bear the brunt of increase in end interest rates.
Delay in Revision of Rates for Borrower vis-à-vis Revision of MCLR
In a falling interest rates scenario, under MCLR, if a borrower avails of the loan on 1st April 2016, and if the bank decides to cut rates on 5th April 2016, the borrower will get the benefit only after a gap of one year. But, at the same time, borrowers would be protected when the rates climb. Even if the rates go up, the new rates would be applicable when they are due for reset.
As an Existing Customer should I change my loan to an MCLR linked loan?
An existing customer should ascertain the following factors before converting his existing floating rate loan from a Base Rate linked loan to an MCLR linked loan,
- The inflationary scenario needs to be analysed to understand whether repo rates will be reduced or increased by RBI. A falling interest rate scenario will result in higher benefit for customers with an MCLR linked loan, while an ascending interest rate scenario will result in higher benefit for customers with Base Rate linked loans.
- Banks still have the Credit Spread as a methodology for safeguarding themselves during a falling interest scenario. Going forward, given a falling interest scenario we may see banks coming up with a lot of longer tenure fixed rate loans.
The latest cut in the repo rate works positively with the MCLR methodology. If you are looking to get a new loan, now is a good time. Explore loans on BankBazaar while the information about MCLR is still fresh in your mind.