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MCLR – Marginal Cost of funds-based Lending Rate

Last Update Date : April 30, 2019
Estimated Read Time: 5 min

MCLR or Marginal Cost of Funds based on Lending Rate means the minimum rate of interest of a bank below which they cannot lend it, except for some cases that are allowed by the Reserve Bank of India. MCLR can work as an internal benchmark or reference rate for a bank.

In this guide by H&R Block, let us see what MCLR is and how is it calculated.

What is MCLR?

The determination process of minimum home loan rate of interest is known as the marginal cost of funds-based lending rate. The RBI introduced this method in the Indian financial system in 2016. The base rate system that was introduced in the year 2010 was replaced by the MCLR system. Ever since renewing credit limits as well as loan sanctions is done on the basis of MCLR norms.

Reason for Introducing MCLR

The RBI’s decision to replace base rate with MCLR was made owing to the fact that the rates based on the marginal cost of the funds are sensitive when it comes to changes in the policy rates which is very important for effective monetary policy implementation. Before MCLR was introduced, different banks and lenders were using different methods to calculate the base rate or minimum rate which was based upon the average cost of the funds or blended cost of the funds or marginal cost of funds.

The reasons for introducing MCLR, therefore, are given as follows:

  • Bringing transparency in the methods that are followed by banks/lenders for arriving at the interest rates on advances.
  • Improving transmission of policy rates in lending rates of banks/lenders.
  • Enabling the banks to become competitive as well as enhance their long-run value and contribution towards the economic growth.
  • Ensuring that bank credits are available at interest rates which are fair to both the banks and borrowers.

How to Calculate MCLR?

You should take into consideration every borrowing sources for a bank for calculating the marginal cost of funds-based lending rate. There are a lot of sources that a bank can borrow from, such as fixed deposits, savings accounts, current accounts, etc. You can use the rate of interest applied on these borrowing sources for calculating the marginal borrowing cost. It is also important for you to know that a bank’s borrowing source is not restricted to funds but also equity. Therefore, you can also expect the return on equity.

The Reserve Bank of India prescribes the MCLR calculation as shown below:

Marginal cost of funds = Marginal borrowing cost x 92% + return of net worth x 8%

MCLR norm describes different components of MCLR. These components can be explained as follows:

Tenor Premium

Tenor premium denotes that a higher rate of interest can be charged from long-term loans.

Negative carry because of CRR

Negative carry is the cost that a bank has to incur while maintaining reserves with the Reserve Bank of India. RBI does not provide an interest for CRR (Cash Reserve Ratio) that a bank holds. The cost of the idle funds can be charged from the loans given to people.

Operating cost

It is nothing, but the operating expenses incurred by the bank.

Marginal Cost of Funds

It is a quite new concept under the MCLR methodology that includes Marginal cost of borrowings and returns on net worth which is appropriately weighed.

The formula for marginal cost of funds will be:

Marginal cost of funds = (92% x Marginal cost of borrowings) + (8% x Return on net worth)

Through the formula, we understand that the marginal cost of borrowings weighs 92% while the return on net worth only weighs 8% in the marginal cost of funds. This means that the weight given on the net worth is equal to 8% of risk-weighted assets as per Tier I capital for a bank.

MCLR Base Rate

MCLR depends on factors such as marginal cost of funds, operating cost, CRR and tenor premium. Base rate depends on factors including bank deposit rates, profit, bank costs, etc.

MCLRBase Rate
MCLR depends on factors such as marginal cost of funds, operating cost, CRR and tenor premium.Base rate depends on factors including bank deposit rates, profit, bank costs, etc.
MCLR was introduced for the end borrowers to enjoy benefits associated with RBI’s repo rate cuts. Banking system has become more transparent after its implementation.The minimum rate of interest that a bank offers for a loan is known as the base rate.
It is dependent on repo rate changes that are made by the Reserve Bank of India.It does not depend on the repo rate changes by RBI.
It can be different for different loan tenures.The decision to change the base rate quarterly depends on the bank.

Deadlines to Disclose Monthly MCLR

The lending rates on the floating rate advances are decided by the banks also consisting of elements spread to MCLR. They also have the freedom to make all the categories of advances available on fixes and floating interest rates. Moreover, banks are required to follow some specific deadlines for disclosing the MCLR or internal benchmark. These deadlines can be any of the following:

  • One month
  • Overnight MCLR
  • Three months
  • One year
  • For a maturity as the banks see fit

The lending cannot be less than the MCLR for any maturity in order to link all loans to the benchmark. Even the loans given on a fixed rate with a duration of three will be priced accordingly.

RBI Guidelines

The Reserve Bank of India has released some guidelines about MCLR as follows:

  • MCLR will not affect home loan at a fixed rate.
  • MCLR for different tenors should be published by the banks.
  • For computing marginal cost of funds, deposit balances and other borrowings are to be considered.
  • MCLR will stand as same till the next reset date in case of floating rate home loan.

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Niteesh Singh
Niteesh is a Tax Researcher and Content Lead at H&R Block (India). He holds an MBA with a specialisation in BFSI domain. In his career spanning over six years, he has helped thousands of people understand taxes in a simple and effective manner. Outside work, Niteesh is an astronomy geek who is also involved in wildlife conservation activities.

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