What is MCLR (Marginal Cost of Funds-based Lending Rate) in banking?

MCLR or Marginal Cost of Funds-based Lending Rate is one of the most important determinants of the rate at which you can avail of loans from any bank or financial institution. If you wish to avail of loans at affordable rates and know the minimum rates at which you can avail of loans, you should be well-versed with the MCLR. Let’s get a deeper understanding of what exactly MCLR is and how it is beneficial for you.

MCLR meaning

To understand how the interest rate is determined for loans, it is important to know what an MCLR actually is. MCLR is the minimum interest rate below which a bank or a financial institution cannot lend you loans. It replaced the base rate system to enable the lending rates for the commercial banks. MCLR was implemented by the RBI on April 1, 2016.

How to calculate MCLR?

Having understood the meaning of MCLR, it is important to know how it is calculated as well. Banks calculate the MCLR to determine the minimum interest rate at which they will be able to lend. Banks calculate the MCLR based on the tenure of the loan. However, MCLR is internal to the bank. The actual lending rate includes the spread over and above the MCLR. Calculation of MCLR takes into account multiple components.

Components of MCLR

Following are the key components of MCLR:

Marginal cost of funds: The cost of funds are important in determining the MCLR in banking. It is the average rate at which the deposits with similar maturities were raised during a specific period. Basically, it involves the cost at which banks obtain funds for lending.
Negative carry on Cash Reserve Ratio (CRR): Banks are required to maintain certain portion of cash reserves with the RBI on which they do not earn any interest. The cost associated with this non-earning reserve is considered as negative CRR.
Operating costs: Third factor is the operational costs incurred by the bank. This normally includes administrative costs, office expenses, employees’ salaries, rental expenses, utility etc.
Tenure premium: The longer the tenure, the higher the risk of loan. Therefore, the bank charges a premium to cover this risk, known as tenure premium. It is determined based on the average maturity of the bank liabilities.

MCLR vs base rate

The main difference between the MCLR and base rate is the method of calculation and their response to the policy changes.
MCLR is the minimum rate calculated by the bank below which it cannot lend. Base rate was used before MCLR came into use and refers to the minimum lending rate for loans.
MCLR is more responsive to policy rate changes as compared to the base rates.
Base rates may not reflect actual fund costs. Considering the benefits of MCLR in banking, RBI introduced it for promoting transparency and effective monetary policy transmission.

When do banks disclose the MCLR?

MCLR was implemented by the Reserve Bank of India to ensure better transparency and pass on the benefits of reduced interest rates to the customers. Therefore, it is mandatory for the banks and other financial institutions to declare their overnight, one month, three months, six months, one year and two-year interest rates on a monthly basis. For borrower's convenience, the MCLR is easily available on the lenders’ website. They can check it in just a click.

Also Read: Low-interest Personal Loans: beginner's guide

In a nutshell

MCLR in banking is one of the important determinants of the rate at which loan will be issued to you. You can check the MCLR on the bank’s website. However, you should keep in mind that the actual lending rate is always the sum of MCLR and spread. You should try to select the lender that offers the competitive interest rate without compromising on the services.

FAQs

What is MCLR in simple terms?
In simple terms, MCLR is the rate below which the banks and financial institutions cannot lend money to the borrowers. It is calculated by the banks after considering the marginal cost of funds, operating costs, tenor premium and negative carry on cash reserve ratio.

Is MCLR decided by the RBI?
The MCLR is decided by the Reserve Bank of India (RBI) and was introduced on April 1, 2016, replacing the erstwhile base rate.

Is MCLR fixed or floating?
MCLR affects the rates that are floating. It is not a fixed rate due to economical changes. Under the MCLR regime, the banks are free to make available fixed and floating interest rate loans.

What is an example of MCLR?
Suppose a bank declares the MCLR of 8%, it means that the bank will disburse loan at MCLR (8%) plus spread @ 2%. Therefore, the final rate of interest for the loan will be 8% + 2% = 10%.

Disclaimer: This article is for information purpose only. The views expressed in this article are personal and do not necessarily constitute the views of Axis Bank Ltd. and its employees. Axis Bank Ltd. and/or the author shall not be responsible for any direct / indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information. Please consult your financial advisor before making any financial decision.