On April 1st, 2016 the Reserve Bank of India introduced the Marginal Cost of Funds based Lending Rate (MCLR) calculation for setting the interest rate on loans. The step changed the way interest rates function in the country. This article will refresh your understanding of MCLR and all you need to know about it.
What is MCLR?
MCLR is a modification of the old base rate system and it is designed to work as a benchmark to set lending rates. MLCR calculations are done on the basis of the interest rate offered by a bank on deposits and the repo rate. The base rate will then be derived on the basis of the MCLR calculations. According to the new guidelines, commercial banks will have to prepare the new internal benchmark lending rate based on the marginal cost of funds.
In the old base rate system, the banks took time to change their interest rate according to the changes in the repo rate. Though there were periodic rate changes from the RBI, banks were reluctant to change their own deposit rates and lending rates. As per the Reserve Bank of India directive, banks have to set their MCLR every month. It means they will have to factor in cost conditions to derive this rate. These conditions include a change in the repo rate, changes in the monetary policy and evaluation of the creditworthiness of the borrower, among other things. Five benchmark rates are required for different tenures which range from 1 day to 1 year. The banks are free to set rates for tenures exceeding 1 year.
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As per the Reserve Bank of India directive, banks have to set their MCLR every month. It means they will have to factor in cost conditions to derive this rate. These conditions include a change in the repo rate, changes in the monetary policy and evaluation of the creditworthiness of the borrower, among other things. Five benchmark rates are required for different tenures which range from 1 day to 1 year. The banks are free to set rates for tenures exceeding 1 year. Banks also have to renew their MCLR rate every month on a pre-announced date
The introduction of the MCLR calculation has lead to a decline in the interest rates for Home Loans, Car Loans, and short-term working loans. Banks cannot lend below the MCLR but there are a few exceptions. For loans against deposits and loans to employees of the respective bank, banks can lend below the MCLR.
Tell me more
When we breakdown Marginal Cost of Funds Lending Rate, it becomes simpler to understand. The term “marginal” in the economic sense means additional or could mean the change in the current state. So the MCLR will be based on the changes in the cost condition which we can refer to as the marginal cost conditions. There are different components that make up the marginal costs.
- Marginal cost of funds which comprises of marginal cost of borrowings and return on net worth
- Negative carry on account of cash repo rate which is the cost banks incur to keep reserves with RBI.
- Operating costs incurred by the banks
- Tenor premium which is the higher interest that can be charged for long-term loans.
Marginal costs are charged based on the following factors as per the RBI guidelines:
- Interest rate offered on deposits including savings, term, and current and foreign currency deposits.
- Return on net worth
- Borrowings meaning the repo rate, short-term interest rate, and the long-term interest rate
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What is the purpose of MCLR?
The MCLR methodology is expected to bring about fair lending and borrowing practices between the banks and the borrowers, primarily with regard to the interest rates. Experts speculate that the new methodology could encourage borrowers to seek bank credit over commercial paper, which has gained much popularity lately. A commercial paper is a debt instrument popular with corporations. This entails the corporations selling securities to raise funds to meet short-term liabilities.
How will it impact me?
The new change is expected to benefit borrowers looking to get a short-term working loan or a Home Loan.
Recalculate your Home Loan EMI.
However, the banks will determine the MLCR rate for each borrower after factoring in the credit risk premium. So keep in mind, while the lending rates might be low, the banks can charge a premium percentage of their choice on the loan amount.
Existing borrowers have the option to continue under the base rate regime or switch to MCLR. Once the switch is made, it cannot be reversed. To make the switch, the customer needs to request the bank to link the loan to MCLR instead of the Base Rate.
You can request the bank to reduce the quantum of spread. There may be a one-time charge applicable for the conversion. Presently, MCLR-linked loans are cheaper than the base rate loans. So a switch could be a good idea. However, customers must keep in mind that if the RBI hikes the rates, this will result in a hike in the rate of interest. Take into consideration the cost of shifting the loan to MCLR and the benefit in interest rates. If the shift amounts to 25 basis points or more, and you have a longer tenure on your loan, then the shift is advisable. But making a shift for a difference of 10 basis points may not be beneficial.
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Exempted Loans
Not all loans come under the umbrella of MLCR. The following offers are exempted, among others:
- Loans covered by government schemes
- Working Capital Term Loan and
- Funded Interest Term Loan disbursed as part of rectification or restructuring package
- Loans granted under government refinance schemes
- Advances to banks’ depositors against their own deposits, to banks’ employees, present and retired
- Advances to the CEO or full-time directors
- Loans linked to a market-determined external benchmark
- Fixed Rate Loans
MCLR for a few banks
| Overnight | 1 Month | 3 Months | 6 Months | 1 Years | 3 Years | 5 Years | |
| Bank of Baroda | 8.10% | 8.15% | 8.20% | 8.30% | 8.35% | 8.50% | 8.65% |
| Overnight | 1 Month | 3 Months | 6 Months | 1 Years | 2 Years | 3 Years | |
| HDFC | 7.85% | 7.85% | 7.90% | 7.95% | 8.15% | 8.25% | 8.45% |
| SBI | 7.75% | 7.85% | 7.90% | 7.95% | 8.00% | 8.10% | 8.35% |
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