Marginal Cost of funds based Lending rate (MCLR).

What is MCLR?

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. MCLR actually describes the method by which the minimum interest rate for loans is determined by a bank – on the basis of marginal cost or the additional or incremental cost of arranging one more rupee to the prospective borrower.

Under the MCLR banks are allowed to offer multiple lending rates linked to the tenor of the loan and each rate was fixed rate for fixed period 

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.

Source: Indian Economic Service & Economic Times

What is base rate?

The Base Rate (replaced by MCLR from April 1, 2016) was the minimum interest rate of a bank below which it could not lend, except in some cases allowed by the RBI. The base rate was introduced with effect from 2010 by the Reserve Bank of India. Base Rate had replaced the benchmark prime lending rate (BPLR).

Source: Indian Economic Service

Why the need for MCLR was felt?

During 2014 – 2016 RBI reduced the interest rates multiple times, but the home loan interest rates did not go down quickly. Banks were reluctant to reduce the lending rates and transfer the rate cuts they received to the customer. The Banks were not passing the benefits of the reduced [popup_anything id=”3727″] to the customers. MCLR was introduced since RBI felt that monetary policy transmission was not happening to full extent. 

Source: Creditmantri

Advantages of 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 would:

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

Source: Indian Economic Service