In the banking industry, lending rates play a crucial role in determining the affordability of loans and other financial products for customers. One such lending rate that has gained significant attention in recent years is the Marginal Cost of Funds based Lending Rate (MCLR). MCLR is a benchmark lending rate used by banks in India to price their loans and advances. This comprehensive overview of MCLR aims to provide readers with a thorough understanding of this concept, its significance in the lending industry, and how it affects borrowers and banks alike. By delving into the intricacies of MCLR, readers can gain valuable insights into the lending market and make informed decisions regarding their financial needs.
What is MCLR Full Form and Meaning
MCLR full form is “Marginal Cost of Funds based Lending Rate”. It is the minimum interest rate that a bank can charge on loans and advances. MCLR is based on the marginal cost of funds, which is the cost incurred by a bank on borrowing funds from various sources such as deposits, borrowings, and other sources. The MCLR system was introduced by the Reserve Bank of India in April 2016 to make lending rates more transparent and to ensure that banks pass on the benefits of lower interest rates to their customers. Under the MCLR system, banks are required to calculate their lending rates based on the current cost of funds, which ensures that the interest rates are more reflective of the prevailing market conditions.
How does MCLR impact home loans?
MCLR has a direct impact on the interest rates charged on home loans. Banks in India use MCLR as a benchmark to determine the interest rates on their loans and advances, including home loans. The interest rate on a home loan is calculated by adding a spread, which is a markup over the MCLR, to arrive at the final lending rate. Therefore, any change in the MCLR will impact the interest rate on the home loan. If the MCLR increases, the interest rate on the home loan will also increase, making the loan more expensive for the borrower. Conversely, if the MCLR decreases, the interest rate on the home loan will also decrease, making the loan more affordable for the borrower. It is important for home loan borrowers to keep an eye on the movement of MCLR as it can have a significant impact on the cost of borrowing.
Difference Between MCLR Rate and Base Rate
Although MCLR and base rates offered by lenders may appear to be similar at first glance, there are significant differences between the two. While both are based on similar principles and serve the same purpose of benchmark lending rates, there are important factors that set them apart.
Firstly, the base rate is calculated based on the average cost of funds, whereas MCLR is based on the marginal or incremental cost of funds. The base rate takes into account the minimum return rate or profit margin, whereas MCLR considers the tenure premium. In addition to this, the base rate is also influenced by operating costs and the costs associated with maintaining the cash reserve ratio, while the MCLR is determined by factors such as the repo rate, deposit rates, operating costs, and the cost of maintaining the cash reserve ratio. These differences make MCLR a more dynamic benchmark rate compared to the now discontinued base rate.
What is the method for calculating the MCLR rate?
When calculating MCLR, it is important to take into account all the borrowing sources used by financial institutions, which include fixed deposits, savings accounts, and current accounts. The interest rate of these borrowing sources can be used to estimate the marginal borrowing cost. It is also worth noting that financial institutions’ sources of funds are not limited to borrowing, as equity returns can also be expected.
The formula prescribed by the Reserve Bank of India (RBI) for calculating MCLR is as follows:
MCLR = Marginal borrowing costX92 percent + net worth returnX8 percent
In addition to this, banks are required to maintain a cash reserve ratio of 4 percent, on which they earn zero interest. As per MCLR, banks can take up a few allowances known as Negative Carry on the CRR. Operating expenses, such as opening branches, raising funds, and paying staff salaries, should also be factored in and taken care of. Lastly, the tenor premium or discount should be considered. The interest rate reset is known as a tenor, and it is directly proportional to the reset period.
MCLR is based on the following factors:
- Operating costs of the bank
- Tenor premium
- Marginal funds cost
- Negative carry on the cash reserve ratio
According to RBI regulations, banks are required to issue their minimum Home Loan interest rate or the MCLR for various tenures on a monthly basis. These tenures include overnight, 1 month, 3 months, 6 months, 1 year, and other tenures that the bank may wish to publish. You can find out the MCLR of various banks by visiting their websites.
Why MCLR?
The central bank’s decision to shift banks to the MCLR system may have left you wondering why, especially since the previous system of base rate/BPLR seemed to be working well. However, the RBI was dissatisfied with the effectiveness of the base rate system and recognized that it was not sensitive to changes in policy rates, which are essential for the proper implementation of monetary policies. It’s worth noting that there was no uniform system in place until the introduction of the MCLR system, and financial institutions used vaious methodologies to calculate their base rates, resulting in inconsistencies.
One of the primary reasons why the RBI shifted banks to the MCLR system was to facilitate a faster and simpler transmission of policy rates to lending interest rates. The MCLR system was introduced to enhance RBI policy rate transmission into the banking system, improve transparency in the process used by financial institutions to set loan interest rates, ensure fairness in credit rates for both borrowers and banks, and provide competitive benefits to banks, which can contribute to the long-term value and economic growth of the country.
FAQs
Q: What is MCLR?
A: MCLR stands for the Marginal Cost of Funds based Lending Rate. It is a benchmark lending rate that is used by banks in India to determine the interest rates on loans.
Q: How often is MCLR revised?
A: Banks are required to review and revise their MCLR every month, and the revised rates come into effect from the first day of the month.
Q: What types of loans are linked to MCLR?
A: Most loans in India, including home loans, car loans, personal loans, and business loans, are linked to MCLR.
Q: What are the benefits of MCLR?
A: The benefits of MCLR include transparency in loan pricing, faster transmission of policy rate changes, and fairer pricing of loans for borrowers. MCLR also promotes competition among banks, which can result in better loan products and services for customers.
Q: Can borrowers switch from base rate to MCLR?
A: Yes, borrowers can switch their loans from the base rate to MCLR. However, banks may charge a conversion fee for this service, and borrowers should carefully consider the costs and benefits before making the switch.
