Marginal cost of funds based lending rate (MCLR)

Marginal cost of funds-based lending rate (MCLR)

Marginal cost of funds-based lending rate (MCLR) is the new benchmark, with effect from 1^st April 2016, at which banks will now lend to new borrowers. It will replace the base rate, which was prevalent till 31 March 2016, as a benchmark rate to lend. 

The MCLR is applicable only for new loans. Existing customers i.e. old loans continue on the base rate regime, till their re-set. Thus, fixed rate loans will continue to carry older rates.

Banks have to publish at least five MCLR rates (overnight, one-month, three-month, six-month and one-year). Banks are also free to set rates for longer durations, such as two and three years. MCLR is to be revised monthly, on a pre-announced date.

If one-year MCLR at 9.20%. and spread for a home loan is 25 bps, you will get loan at 9.45%.

MCLR is closely linked to the actual deposit rates, in addition to the repo rate (rate for obtaining funds from the RBI). Hence, the new rate regime is likely to improve transmission of rates to the end consumers. Currently, MCLR is, on an average, 10 bps cheaper than base rate linked on a like-to-like basis.

MCLR is applicable only for banks (and not to NBFCs).

Comparison with Base rate

Base rate system was introduced by RBI in July 2010 to ensure that banks can not lend below a certain benchmark. However, base rate method was felt to be not as effective, since RBI has cut rates by 150 bps since Jan 2015, but banks have lowered their base rate by only 50-60 basis points till March 2016. While cost of funds for banks have come down thanks to repo cuts, lending rates were not lowered as banks’ average cost of borrowing remained high because of older fixed deposits.

The purpose of changing the repo by RBI is realized only if the banks are changing their individual lending and deposit rates, so as to pass it on to the actual users. Else, RBI move is futile in boosting the consumption and investment cycle of the economy.   

In concept, MCLR is not very different from prime lending rate (in use prior to base rate) or base rate, except in the methodology to calculate. Spread over MCLR or base rate or prime lending rate remains, which is charged by banks. Also, similar to base rate, banks can’t lend below MCLR.

Calculation of MCLR

While calculating the MCLR, costs that the bank is incurring to get funds (means deposit) is calculated on a marginal basis. The marginal costs also include repo rate, which was not included under the base rate.

Since MCLR is a tenor-based benchmark (instead of a single rate), banks can efficiently price loans at different tenors based on different MCLRs, according to their funding composition and strategies. Under the base rate, average cost of funds based calculation was used which primarily dependent on composition of CASA (Current Accounts & Savings Account).