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Marginal Cost of Funds based Lending Rate (MCLR) is the minimum interest rate, below which a bank is not permitted to lend. RBI can give authorization for the same in exceptional cases. This article covers the following:

  1. What is MCLR?
  2. Outcome of MCLR implementation
  3. How to calculate MCLR?
  4. How is MCLR different from Base Rate?
  5. What are the deadlines to disclose monthly MCLR?


1. MCLR or Marginal Cost of fund based Lending Rate

MCLR (Marginal Cost of funds based Lending Rate) replaced the earlier base rate system to determine the lending rates for commercial banks. RBI implemented it on 1 April 2016 to determine rates of interests for loans. It is an internal reference rate for banks to decide what interest they can levy on loans. For this, they take into account the additional or incremental cost of arranging additional rupee for a prospective buyer.


2. Outcome of MCLR

After MCLR implementation, the interest rates will be determined as per the relative riskiness of individual customers. Previously, when RBI reduced the repo rate, the 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.



3. How to calculate MCLR? 

MCLR calculation is linked to the tenor or the amount of time a borrower has to repay the loan. This tenor-linked benchmark is internal in nature. They determine the actual lending rates by adding the elements spread to this tool. The banks, then, publish their MCLR after careful review. The same process applies for loans of different maturities – monthly or as per a pre-announced cycle.

The four main elements of MCLR are made up of the following:

a. Tenor premium

There is uniformity in the tenor period for all sorts of loans for the said residual tenor. This means that the tenor premium is not specific to a loan class or a borrower.

b. Marginal cost of funds

The Marginal Cost of Borrowing is the average rate using which the deposits with similar maturities were raised during a specific time period before the review date. It will reflect in the bank’s books by their outstanding balance.

Marginal Cost of Borrowing has several components like the Return on Net Worth and the Marginal Cost of Borrowings. Marginal Cost of Borrowings takes up 92% while the Return on Net Worth accounts for 8%. This 8% is equivalent to the risk of weighted assets as denoted by the Tier I capital for banks.

c. Operating Cost

Operational expenses include cost of raising the funds, barring the costs recovered separately by means of service charges. It is, therefore, connected to providing the loan product as such.

d. Negative carry on account of CRR

Negative carry on the CRR (Cash Reserve Ratio) takes place when the return on the CRR balance is zero. Hence, when the actual return is less than the cost of the funds, there arises the negative carry. This will impact the mandatory Statutory Liquidity Ratio Balance (SLR) – reserve every commercial bank must maintain.


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4. How is MCLR different from Base Rate?

MCLR is actually an improved version of plain vanilla base rate. It is a risk-based approach to determine the final lending rate for borrowers. It considers unique factors like marginal cost of funds instead of the overall cost of funds. Such marginal costs take into account repo rate, which did not form part of the base rate.

While calculating MCLR, banks need to incorporate all other kinds of interest rates which they incur while mobilizing funds. Previously, the loan tenure was not at all an important factor. In case of MCLR, the banks should now include a tenor premium. This means they can charge a higher rate of interest for loans with long-term horizons.

5. What are the deadlines to disclose monthly MCLR?

Banks have the liberty to make available all loan categories under fixed or floating interest rates. Additionally, banks need to follow specific deadlines to disclose the MCLR or the internal benchmark. They could be one month, overnight MCLR, three months, one year or a maturity as the bank deems fit

To link all loans to the benchmark, the lending cannot be below the MCLR for any maturity. Loans that are not linked to MCLR include loans against customers’s own deposit, loans to the bank’s employees, special loan schemes by Government of India (Jan Dhan Yojana), fixed rate loans with tenures above three years etc.


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