What Is MCLR (Marginal Cost of Funds-Based Lending Rate) in Banking?

MCLR (Marginal Cost of Funds-Based Lending Rate) replaced the base rate system on April 1st, 2016. Introduced by the Reserve Bank of India (RBI), this system aims to improve transparency, ensure fairness, and provide benefits to borrowers by more accurately reflecting the cost of funds for commercial lenders.

Understanding the meaning of MCLR and its impact on loan rates can help applicants make informed decisions and potentially save on borrowing costs.

This article will cover the basics of MCLR, including MCLR rate calculation and its components. We’ll also compare MCLR with the base rate and RPLR (Retail Prime Lending Rate) to highlight key differences.

MCLR Meaning

MCLR refers to the method used by lending firms to set interest rates. It represents the minimum rate below which lending institutions are not permitted to lend, ensuring that lending rates are more reflective of the current cost of funds. This allows borrowers to benefit from lower interest rates when the cost of funds decreases.

The system of MCLR links loan rates to the marginal cost of funds, thus making them more dynamic and responsive to economic changes. Factors such as repo rates, operational costs, and other borrowing costs impact the MCLR. Lending firms typically review and adjust the MCLR periodically, often on a monthly basis.

The impact of MCLR on loan products such as personal loans is evident in how EMIs can increase or decrease depending on the direction of the MCLR movement.

How to Calculate MCLR?

Several factors must be considered to calculate the MCLR rate such as the marginal cost of funds (MCOF), operating expenses, and the negative carry on the CRR (Cash Reserve Ratio).

MCLR rates are set for different loan tenures, such as overnight, one month, three months, six months, one year, etc., allowing borrowers to choose loans based on their preferred repayment period. 

While the specific methodology may vary from one lender to another, all of them must follow the RBI’s MCLR guidelines. Typically, the MCLR rate is calculated using the following formula:

MCLR = MCOF + Negative Carry on CRR + Operating Costs + Tenor Premium

Let’s explore these components in more detail.

Components of MCLR

Marginal Costs of Funds (MCOF): Depicts the incremental cost sustained by lenders to raise funds. It includes the cost of deposits, borrowings, and other funds, and is influenced by the interest rates associated with these sources.

Negative Carry on Cash Reserve Ratio (CRR): Refers to the opportunity cost incurred by lending institutions for holding mandatory cash reserves with the RBI, which do not earn any interest. The negative carry occurs because lenders must set aside a portion of their funds as reserves, which could otherwise be used to earn returns.

Operational Costs: Consists of all the expenses incurred by the lending firm to maintain its operations, such as employee salaries, rent, and administrative costs.

Tenor Premium: A premium added to the MCLR based on the tenure of the loan. It accounts for the additional risk associated with lending for longer durations, ensuring that longer-term loans are priced appropriately.

What Is the Impact of MCLR?

MCLR affects all borrowers, particularly those with floating interest rate loans, as it directly responds to changes in RBI policies. For instance, if the RBI lowers the repo rate, lending companies might lower their MCLR. This way, people can access loans at lower interest rates. Conversely, if the RBI increases the repo rate, MCLR might rise, leading to higher EMIs for borrowers with floating rates.

The goal of MCLR is to create a transparent and dynamic rate system, allowing borrowers to better understand how policy changes impact their loan rates.

To better understand the impact of MCLR on loans, consider the following scenarios:

Case 1: You Borrowed Before 1st April, 2016

If your loan was taken before MCLR was introduced and is still tied to the base rate, you can request a shift to the MCLR structure. Doing so may help you secure a lower interest rate, as MCLR tends to reflect the current cost of funds more accurately than the base rate.

Case 2: Your Loan Tenure Will End Soon

Switching to the MCLR rate near the end of your loan may not result in significant savings, as the potential interest rate differences over the remaining months are minimal. In such cases, it might be more practical to continue with the base rate to save on the administrative costs and effort associated with switching.

MCLR vs Base Rate

The base rate was the minimum lending rate system set by financial institutions before MCLR was implemented in 2016. Let’s see what sets it apart from MCLR:

• Flexibility: MCLR adjusts more rapidly to changes in market conditions, such as fluctuations in the repo rate, whereas the base rate is less responsive to these shifts. This responsiveness allows MCLR to better reflect current economic conditions.
• Borrower Benefits: MCLR often results in a lower cost of borrowing because it is aligned with current market trends, typically offering more competitive interest rates compared to the older base rate.
• Calculation Focus: MCLR is calculated based on the current cost of funds, which is why it is more aligned with the latest market conditions. The base rate, on the other hand, considers historical costs, making it less sensitive to recent changes in the financial environment.

Deadlines to Disclose Monthly MCLR Rates

Lending firms are required to disclose their monthly MCLR rates for various loan tenures (such as 1, 3, or 6 months) by the last working day of each month.

Typically, the revised MCLR loan rates, such as the MCLR rate for personal loans, are published on the official website of the lending company. This can help potential borrowers understand how MCLR works and its impact on their loans.

It is also important to note that the MCLR rate must be reset annually, even if there have been no changes in the marginal cost of funds incurred by the lender. In cases where lenders lack sufficient data on their marginal cost of funds, they may reference the benchmark deposit rate set by the RBI as a guideline. 

How to Convert Base Rate to MCLR?

If your loan is linked to the base rate system and you wish to switch to the MCLR rate, the best way forward is to contact your lender. You can submit your request by reaching out to the appropriate representatives online or by visiting the branch in person.

It is important to note that some lenders may charge a fee for switching your loan to the MCLR rate system. Before proceeding, inquire about any associated costs or documentation requirements. Once the switch is approved and completed, you will benefit from interest rates that more accurately reflect current market conditions, potentially resulting in lower borrowing costs. 

In a Nutshell

The market-sensitive approach of the MCLR rate has transformed the lending industry. It provides borrowers with greater transparency and a more dynamic framework compared to the traditional base rate system.

At SMFG India Credit, we uphold the fair lending practices that are the primary motivation behind MCLR by offering competitive interest rates on personal loans. Additionally, our online EMI calculator can help you estimate the impact of different interest rates on your monthly payments. If you’re looking for a reliable financial solution to fund your personal or business expenses, reach out to us today!