What is MCLR?

Earlier, interest rates charged by the banks depended on the ‘Base Rate’ system. It was the rate below which it was not feasible for the banks to extend loans.

The MCLR or Marginal Cost of Funds based Lending Rate methodology for fixing rate of interests was introduced in April 2016. It implied that all the rupee loans extended and credit limits renewed after April 1, 2016, will be with reference to the MCLR. It has become the internal benchmark rate of banks for extending loans.

Factors affecting MCLR:

The key components of the MCLR calculation are-

  • Marginal Cost of Funds: It is the most unique element of MCLR regime. It is based on factors such as interest rate given on savings accounts, term deposit, short term interest rate or repo, and return on net worth, among other factors
  • No return on Cash Reserve Ratio (CRR): Banks do not get any interest on the reserves kept with RBI 
  • Operating costs: These are the costs incurred by the banks towards their operation
  • Tenure premium: It signifies that higher interest can be charged on long-term loans

Key differences between the MCLR and Base Rate systems:

  • The critical difference between the Base Rate system and the MCLR is the calculation of marginal cost. In the base rate system, it was calculated by taking a simple average of the interest rates spent on deposits.
  • However, under the new system, the interest rates are calculated according to the following parameters-
  • The marginal calculation of the cost that the bank is incurring to arrange the deposits
  • The repo rate is included in the marginal cost, which was not the case with the Base Rate system. It means the new interest rates are directly related to the changes in repo rates implemented by the RBI
  • Minor interest rates are also considered by banks while calculating the costs
  • Based on the calculation system, the MCLR rates should be revised on a monthly basis

What types of loans are linked to MCLR?

All the loans with a floating interest rate sanctioned after April 1, 2016, are linked to the MCLR rate. Existing customers have the option to switch to the new regime. The following loans are covered under MCLR-

  • Home loan
  • Loan against property
  • Corporate term loan