Prior to 1st April 2016, if you went to a bank to avail of a loan, you would be charged an interest rate calculated on a base rate. However, this system of setting an interest rate caused issues with respect to transparency as well as delays in rate adjustment as per changes in the economy. The Reserve Bank of India revised its policy and introduced a system based on the MCLR (Marginal Cost of Funds Based Lending Rate). This heralded much-needed reforms in the lending structure of banks and financial institutions.
This article explains MCLR in detail – what is MCLR, how is MCLR calculated, the difference between MCLR and base rate, current MCLR, RBI guidelines and more. Keep reading!
What is MCLR?
Banks and lending institutions that come under the purview of the Reserve Bank of India must follow certain guidelines. When it comes to lending, the central bank announces an interest rate that serves as the minimum interest rate below which, in most cases, a bank cannot lend. This is known as MCLR (full form: Marginal Cost of Funds based Lending Rate).
How is this rate calculated? Let us find out in the next section.
How is MCLR Calculated?
There are various factors that go into the calculation of MCLR:
Operating Expenses: The operating expenses incurred by the bank while extending the loan are also covered by this rate. This may include the cost of raising funds, as well as other expenses including stamp duty, legal charges, printing costs, and more.
Negative Carry-On CRR: Cash Reserve Ratio (CRR) is the specified percentage of total deposits that the bank must keep in its reserves. This amount cannot be extended as a loan, and thus earns no returns. Because of the nil returns, the cost of these funds exceeds what can be earned on them, giving a negative figure. This is known as a negative carry-on CRR.
Tenure: MCLR is calculated by keeping in mind the tenure of the loan, which is the duration for which the loan has been taken. As the tenure increases, so does the risk involved. To cover this risk, the banks charge a premium, which is also taken into account when determining the MCLR interest rate.
Cost of borrowings: Based on the cost of borrowings, the RBI has determined the following formula for calculating MCLR: MCLR = (Marginal borrowing cost * 92%) + (Return on net worth * 8%)
The marginal cost of borrowings is the cost incurred by the bank to raise additional funds. It is the average rate at which deposits with a similar maturity can be raised before the date of the review. These are assigned weights based on their outstanding balance as per the bank’s books of accounts. The other part of the equation, which is the return of net worth, is the return that the bank earns on its equity.
The calculation is well defined and follows a uniform structure as prescribed by the RBI. But why did the RBI shift to the MCLR from the base rate regime to determine lending rates? Let us find out.
The base rate system that was in use before MCLR was introduced had a fair share of drawbacks. It lacked transparency to the customers and was incapable of responding quickly to policy changes made by the RBI. The introduction of MCLR led to the establishment of a uniform rate structure in the country. With this, customers could seamlessly compare rates offered by different banks.
Moreover, under the MCLR regime, banks are allowed to price their loans independently, which gives them the flexibility to change their lending rates per the RBI’s monetary policy. This is done promptly with the adjustments in policies, and delays are avoided.
The MCLR does not just benefit the borrowers, but it provides a competitive advantage to lenders, all of which ultimately boosts the country’s economic growth.
What are the RBI Guidelines on MCLR?
RBI has prescribed the following guidelines regarding MCLR:
1. The reset period for MCLR should be at least one year. This must be done even if there has been no change in the marginal cost of funds.
2. The banks are allowed to review and reset their MCLR once a month.
3. The new MCLR will be effective from the 1st day of the following month.
4. The banks have to mandatorily display the MCLR on their website as well as at their branches.
5. If a bank doesn’t have sufficient data regarding its marginal cost of funds, then it has to use the RBI’s benchmark deposit rate for that particular tenure to calculate the MCLR.
6. The MCLR does not affect home loans that charge interest on a fixed rate basis. For home loans on a floating interest rate basis, the MCLR of the day when the loan is sanctioned is taken till the time it is reset.
The current MCLR varies from bank to bank. This means that the MCLR of HDFC Bank, for instance, will differ from the Axis Bank MCLR.
MCLR as on 23 June 2022 of some of the major banks are given below:
Axis Bank MCLR rate
Kotak MCLR rate
SBI Bank MCLR rate
ICICI MCLR rate
HDFC Bank MCLR rate
IndusInd Bank MCLR rate
IDBI Bank MCLR rate
Source: Bank Websites
Difference between MCLR and Base Rate
MCLR and base rate can be differentiated as follows:
1. The base rate is the minimum interest rate that a bank can charge to its customers. On the other hand, MCLR is the minimum interest rate below which a bank is not allowed to lend.
2. MCLR takes into account the marginal cost of funds while the base rate doesn’t.
3. The RBI has stopped banks from lending at rates below the base rate. However, there is no such restriction on MCLR.
4. The reset period for MCLR is mostly annual but can be shorter in some cases. On the other hand, the reset period for the base rate is quarterly.
5. The changes made by RBI in the repo rate are transmitted faster under MCLR as compared to the base rate.
6. MCLR is calculated on a monthly basis, while the base rate is calculated on a quarterly basis.
7. The transparency provided to customers is higher in the case of MCLR as compared to the base rate.
8. The base rate doesn’t take into account the credit risk premium while calculating lending rates. However, MCLR does take into account the credit risk premium.
9. As per RBI guidelines, banks are not allowed to offer loans at rates below the base rate. There is no such restriction on MCLR.
Thus, we can see that there are quite a few differences between MCLR and base rate. MCLR is a more transparent and effective system as compared to the base rate.
What are the Deadlines to Disclose the Monthly MCLR?
The banks must display the monthly MCLR on their website as well as at their branches before the last working day of every month. This is a crucial guideline issued by the RBI that must be complied with.
What happens if your bank doesn’t disclose the MCLR? If your bank doesn’t disclose the MCLR, then it is violating the RBI guidelines. You can lodge a complaint with the specified banking personnel in this case.
Yes, all banks are required to link their loans to MCLR with effect from 1st April 2016. This is in line with the RBI’s guidelines that were issued in December 2015.
The RBI’s guidelines on MCLR are quite helpful in ensuring that banks lend at rates that are based on the marginal cost of funds. This makes the system more transparent and effective. The customers also benefit as they can now compare lending rates offered by different banks easily. Do make sure to check the MCLR before taking a loan from a bank. It will allow you to get the best possible deal while taking out a loan.
FAQs on MCLR
Q1. What is MCLR?
Ans:MCLR or the Marginal Cost of funds based Lending Rate is a rate specified by RBI which serves as the minimum rate below which banks cannot extend a loan, except in certain cases.
Q2. Why was MCLR introduced by the RBI?
Ans:RBI introduced MCLR to bring in more transparency to the way lending rates are determined by banks. Another reason was to allow seamless and quick adjustment of the lending interest rate based on policy changes by the RBI.
Q3. What are the components of MCLR?
Ans:MCLR interest rate is based on the tenure of the loan, the cost of funds, operating expenses of the bank, and the negative carry on the CRR.
Q4. What is the formula given by RBI to calculate MCLR?
Ans:RBI has prescribed the following formula for calculating MCLR: MCLR = (Marginal borrowing cost * 92%) + (Return on net worth * 8%)
Q5. What is the deadline for banks to disclose the monthly MCLR?
Ans:The banks must disclose the monthly MCLR by the last working day of every month. This must be displayed on their website and bank branches.
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This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
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