What is the Full Form of MCLR?

MCLR stands for Marginal Cost of Fund Based Lending Rate. It is the fixed internal reference rate for banks and lending institutions set by the Reserve Bank of India (RBI). Banks under the RBI use the MCLR to define the minimum interest rates applicable to various types of loans.

Key Points about MCLR:

• Introduced in April 2016 to help borrowers benefit from RBI’s rate cuts.
• Replaces the base rate structure operational since July 2010.
• Updated by the RBI periodically based on changes in economic activities.
• Banks generally cannot lend money below the MCLR.

Marginal Cost of Funds Based Lending Rate (MCLR)

The Marginal Cost of Funds Based Lending Rate (MCLR) is a benchmark interest rate set by the Reserve Bank of India (RBI), which is the primary regulator of banks and financial institutions in India. It represents the minimum lending rate below which banks are not permitted to sanction loans.

Why was MCLR introduced?

The MCLR was introduced by the RBI to address the following issues:

• Banks were not quick to change their interest rates in response to changes in the repo rate and other rates set by the RBI.
• Most commercial banks did not change their lending rates for customers, even when the RBI changed its rates.
• As a result, bank customers did not receive the benefits of the changes in the RBI’s rates.
• Until 2016, the RBI had been verbally instructing commercial banks to change their lending rates with every repo rate change, but this was not always effective.

The MCLR was introduced to address these issues and ensure that bank customers receive the benefits of changes in the RBI’s rates. With the MCLR, banks are required to change their lending rates quickly in response to changes in the repo rate, as the repo rate is included in the MCLR calculation.

Benefits of MCLR

The MCLR has several benefits for bank customers, including:

• Lower interest rates on loans: The MCLR has led to lower interest rates on loans, as banks are now required to pass on the benefits of lower repo rates to their customers.
• More transparency: The MCLR has increased transparency in the lending process, as banks are now required to disclose their MCLR rates publicly.
• Better customer service: The MCLR has improved customer service, as banks are now more responsive to customer requests for lower interest rates.

The MCLR is a significant reform in the Indian banking sector that has benefited bank customers by lowering interest rates, increasing transparency, and improving customer service.

MCLR vs Base Rate

The base rate is a crucial concept in the banking industry, particularly concerning loans. It represents the minimum interest rate set by the Reserve Bank of India (RBI) below which banks are not permitted to lend to their customers. Unless there is a specific government mandate, the RBI rule stipulates that banks cannot offer loans at an interest rate lower than the base rate.

Key Differences:

1. Definition:

• MCLR: Marginal Cost of Funds-based Lending Rate is the minimum lending rate below which banks cannot lend to their customers.
• Base Rate: The base rate is the minimum interest rate set by the RBI below which banks are not allowed to lend.

2. Calculation:

• MCLR: MCLR is calculated based on the marginal cost of funds, operating expenses, and a spread.
• Base Rate: The base rate is determined by considering various factors such as the cost of funds, operating expenses, and a profit margin.

3. Purpose:

• MCLR: MCLR aims to ensure that banks lend at a rate that covers their costs and provides a reasonable profit margin.
• Base Rate: The base rate serves as a benchmark for banks to set their lending rates and ensures that they do not lend below a certain threshold.

4. Impact on Borrowers:

• MCLR: Changes in MCLR directly affect the interest rates charged on loans, impacting the borrowing costs for individuals and businesses.
• Base Rate: Fluctuations in the base rate influence the minimum lending rates offered by banks, thereby affecting the availability and cost of credit.

5. Regulatory Oversight:

• MCLR: MCLR is regulated by the RBI and banks are required to disclose their MCLR on a monthly basis.
• Base Rate: The base rate is also regulated by the RBI, and banks are mandated to disclose their base rate publicly.

In summary, while both MCLR and the base rate are important concepts in banking, they differ in their definitions, calculation methods, purposes, impact on borrowers, and regulatory oversight. Understanding these differences is crucial for individuals and businesses seeking loans and managing their finances effectively.

MCLR and Base Rate

How is the MCLR Calculated?

The MCLR is calculated based on the loan tenor, which is the period a borrower has to repay the loan. The tenor-related benchmark is internal, and banks determine the actual lending rates by adding elements spread to the tool.

Banks publish their MCLR after careful evaluation. The same process applies to loans of different maturities, either monthly or as per a predetermined period. The four main elements of the MCLR are:

Tenure Premium

• The cost of lending varies with the loan period.
• The longer the duration of the loan, the higher the risks associated with it.
• As a risk management measure, banks shift the burden to borrowers by charging a premium known as the Tenure Premium.

Marginal Cost of Funds

• This is the average rate at which deposits with similar maturities were raised during a time frame before the review date.
• The marginal cost of funds includes components like the Return on Net Worth at 8% and the Marginal Cost of Borrowings at 92%.

Operating Cost

• The operational costs of raising funds, excluding costs recovered separately through service charges, are directly connected to the loan.
• These costs are related to providing the loan.

Negative Carry on Account of CRR

• The negative carry on the Cash Reserve Ratio (CRR) occurs when the return on the CRR balance is zero.
• Negative carry arises when the actual return is not more than the cost of funds.

Marginal Cost of Fund Based Lending Rate (MCLR)

The Marginal Cost of Fund Based Lending Rate (MCLR) is a benchmark interest rate set by the Reserve Bank of India (RBI) below which banks cannot lend. It is calculated based on the marginal cost of funds, which includes the cost of borrowing funds from the market, the cost of maintaining reserves, and the cost of operating the bank.

Components of MCLR

The RBI has included the following components in the marginal cost:

• Return on net worth (capital adequacy norms)
• Repo rate (short-term borrowing rate) and long-term borrowing rate
• Interest rate given by banks
• Savings deposit
• Term deposit
• Current deposit
• Foreign currency deposit

Benefits of MCLR

The MCLR revised on a monthly basis benefits bank customers, especially those who borrow loans. It also benefits the banks as they can compete with the commercial paper market and reduce borrowing costs for companies. Additionally, the Indian banking industry moves towards international standards with the implementation of MCLR.

Bottlenecks of MCLR

The MCLR rule exempted loans given to retired employees, existing employees, government schemes, etc. Banks may also be reluctant to change to the MCLR rule due to the cut in interest rates. Currently, it is up to the customer to exercise their loans under MCLR as an alternative.