The marginal cost of funds based lending rate (MCLR) refers to the minimum interest rate of a bank below which it cannot lend, except in some cases allowed by the RBI. It is an internal benchmark or reference rate for the bank.

The MCLR methodology for fixing interest rates for advances was introduced by the Reserve Bank of India with effect from April 1, 2016. This new methodology replaces the base rate system introduced in July 2010.

Reasons for introducing MCLR

RBI decided to shift from base rate to MCLR because the rates based on marginal cost of funds are more sensitive to changes in the policy rates. This is very essential for the effective implementation of monetary policy. Prior to MCLR system, different banks were following different methodology for calculation of base rate /minimum rate – that is either on the basis of average cost of funds or marginal cost of funds or blended cost of funds. Thus, MCLR aims

• To improve the transmission of policy rates into the lending rates of banks.
• To bring transparency in the methodology followed by banks for determining interest rates on advances.
• To ensure availability of bank credit at interest rates which are fair to borrowers as well as banks.
• To enable banks to become more competitive and enhance their long run value and contribution to economic growth.

Source: Indian Economic Service