The Marginal Cost of Funds Based Lending Rate (MCLR) is the internal benchmark set by banks to determine minimum lending rates, as mandated by the Reserve Bank of India. Introduced in April 2016, MCLR replaced the older base rate system, aiming to make interest rate transmission more transparent and market-linked.
This article will provide an overview of MCLR, including its calculation, implementation, impact on loans, benefits, limitations, and key differences from the earlier base rate system.
The Marginal Cost of funds-based Lending Rate (MCLR) is the minimum lending rate below which a bank is not permitted to lend. MCLR replaced the earlier base rate system for determining the lending rates for commercial banks.
RBI implemented MCLR on 1 April 2016 to determine rates of interests for loans. It is an internal reference rate for banks to determine the interest they can levy on loans. For this, they take into account the additional or incremental cost of arranging an additional rupee for a prospective buyer.
After the implementation of MCLR, the interest rates are determined as per the relative risk factor of individual customers. Previously, when RBI reduced the repo rate, banks took a long time to reflect it in the lending rates for the borrowers.
Under the MCLR regime, banks must adjust their interest rates as soon as the repo rate changes. The implementation aims at improving the openness in the structure followed by the banks to calculate the interest rate on advances.
It also ensures the prospect of bank credits at the interest that is true to the consumers as well as the banks.
MCLR is calculated based on the loan tenor, i.e., the amount of time a borrower has to repay the loan. This tenor-linked benchmark is internal in nature. The bank determines the actual lending rates by adding the elements spread to this tool.
The banks, then, publish their MCLR after careful inspection. The same process applies for loans of different maturities, be it monthly or as per a pre-announced cycle.
The four main elements of MCLR are made up of the following:
Banks publish different types of MCLR for different tenures:
Banks reset your loan interest rate based on the MCLR tenure it’s linked to (e.g., if your loan is linked to the 1-year MCLR, the rate will reset annually).
Feature | MCLR (Marginal Cost of Funds Based Lending Rate) | Base Rate |
How It’s Calculated | Based on the marginal cost of funds, including repo rate and recent borrowings | Based on the overall cost of funds without including the repo rate |
Interest Rate Drivers | Reflects market-linked components like repo rate | Depends more on internal bank costs and less on monetary policy changes |
Loan Tenure Impact | Includes a tenor premium, allowing rates to vary by loan duration | The same rate is applied regardless of how long the loan runs |
Rate Transmission | Faster transmission of RBI rate changes to borrowers | Slower to reflect policy rate movements |
Benefit to Borrowers | More responsive and flexible, especially in falling interest rate cycles | Offers less scope for rate cuts to reach borrowers |
Overall Approach | Dynamic, market-responsive, and risk-based | More rigid, uniform, and less sensitive to current monetary conditions |
MCLR directly affects the interest you pay on floating-rate loans. When a bank revises its MCLR (due to changes in repo rate, CRR, or funding costs), your loan EMI can either increase or decrease after the next reset period.
For example, if your loan is linked to the 1-year MCLR and the bank reduces the rate, your EMI will only reflect this cut after the annual reset date, not immediately. This makes MCLR less responsive than repo-linked lending rates (RLLR), but still better than the older base rate system.
Banks have the liberty to make all loan categories available at fixed or floating interest rates. Additionally, banks need to follow specific deadlines to disclose the MCLR or the internal benchmark. These could be one month, overnight MCLR, three months, one year, or any other maturity as the bank deems fit.
The lending rate cannot be below the MCLR for any loan maturities. However, there are other loans that are not linked to MCLR. These include loans against customers’ deposit, loans to the bank’s employees, special loan schemes by the Government of India (Jan Dhan Yojana), fixed-rate loans with tenures above three years.