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Marginal Cost of Funds-based Lending Rate (MCLR)

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  • Published
    26th Sep, 2019

All commercial banks announced cuts in MCLR after Reserve Bank of India cut the repo rate by 35 basis points (bps) to 5.40 from 5.75.


All commercial banks announced cuts in MCLR after Reserve Bank of India cut the repo rate by 35 basis points (bps) to 5.40 from 5.75.


  • The marginal cost of funds-based lending rate (MCLR) is the minimum interest rate that a bank can lend at.
  • MCLR is determined internally by the bank depending on the period left for the repayment of a loan.
  • The RBI introduced the MCLR methodology for fixing interest rates from 1 April 2016. It replaced the base rate structure, which had been in place since July 2010.
  • It is calculated based on four components:
    1. The marginal cost of funds is the cost which one has to bear to raise new (incremental) fund. Suppose I have funds of average interest rate of 10% per annum. I raise some new fund bearing interest rate of 8% per annum then marginal cost of my fund is 8%.
    2. The tenor premium is not borrower-specific and is uniform for all types of loans.
    3. Operational expenses include the cost of raising funds, barring the costs recovered separately through service charges. It is, therefore, connected to providing the loan product as such.
    4. Negative carry on the CRR (Cash Reserve Ratio) takes place when the return on the CRR balance is zero. Negative carry arises when the actual return is less than the cost of the funds. This will impact the mandatory Statutory Liquidity Ratio Balance (SLR) – reserve every commercial bank must maintain.
  • Under the MCLR regime, banks are free to offer all categories of loans on fixed or floating interest rates.
  • After the implementation of MCLR, the interest rates are determined as per the relative risk factor of individual customers. Previously, when RBI reduced the repo rate, banks took a long time to reflect it in the lending rates for the borrowers. Under the MCLR regime, banks must adjust their interest rates as soon as the repo rate changes.

How is MCLR different from Base Rate?

  • MCLR is an improved version of the base rate. It is a risk-based approach to determine the final lending rate for borrowers. It considers unique factors like the marginal cost of funds instead of the overall cost of funds. The marginal cost takes into account the repo rate, which did not form part of the base rate.
  • When calculating the MCLR, banks are required to incorporate all kinds of interest rates which they incur in mobilizing the funds. Earlier, the loan tenure was not taken into account when determining the base rate. In the case of MCLR, the banks are now required to include a tenor premium. This will allow banks to charge a higher rate of interest for loans with long-term horizons.

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