Marginal Cost of Funds based Lending Rate (MCLR)

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Overview:

State Bank of India (SBI) recently raised its marginal cost of funds-based lending rate (MCLR) by up to 10 basis points for selected tenures.

About Marginal Cost of Funds based Lending Rate (MCLR)

  • MCLR is the minimum lending rate below which a bank is not permitted to lend.
  • It is aimed at facilitating the calculation of the minimal interest rate for various types of loans that banks offer.
  • The Reserve Bank of India (RBI) introduced the MCLR methodology for fixing interest rates on April 1, 2016, in order to enhance the effectiveness of monetary policy transmission as well as increase transparency in the rate of interest setting procedure. 
  • It replaced the base rate structure, which had been in place since July 2010.
  • How is MCLR calculated?
    • MCLR is determined internally by the bank depending on the period left for the repayment of a loan.
    • MCLR is closely linked to the actual deposit rates and is calculated based on four components:
    • the marginal cost of funds
    • negative carry on account of cash reserve ratio
    • operating costs
    • tenor premium.
  • Under the MCLR regime, banks are free to offer all categories of loans at fixed or floating interest rates.
  • The actual lending rates for loans of different categories and tenors are determined by adding the components of spread to MCLR.
  • Therefore, the bank cannot lend at a rate lower than the MCLR of a particular maturity for all loans linked to that benchmark.
  • Banks review and publish MCLRs of different maturities, every month. 
  • Certain loan rates, like those of fixed-rate loans with tenors above three years and special loan schemes offered by the government, are not linked to MCLR.

What is the difference between MCLR and Base rate?

  • MCLR is an advanced version of the base rate.
  • The base rate is the minimum rate of interest set by the RBI; no financial institution can lend at an interest rate below the base rate.
  • MCLR is an internal benchmarking system applied by a financial institution, under which they can set their own lending rates considering a spread factor.
  • The base rate is based on the average cost of funds, but the MCLR is based on the marginal or incremental cost of money.
  • The base rate does not get impacted by the revision of RBI’s repo rate, while MCLR gets impacted as and when RBI revises the repo rate.
  • Usually, the minimum rate of return or profit margin is taken into consideration while deriving the base rate. While determining the MCLR, the tenor premium is taken into consideration.About Marginal Cost of Funds based Lending Rate (MCLR):
  • MCLR is the minimum lending rate below which a bank is not permitted to lend.
  • It is aimed at facilitating the calculation of the minimal interest rate for various types of loans that banks offer.
  • The Reserve Bank of India (RBI) introduced the MCLR methodology for fixing interest rates on April 1, 2016, in order to enhance the effectiveness of monetary policy transmission as well as increase transparency in the rate of interest setting procedure. 
  • It replaced the base rate structure, which had been in place since July 2010.
  • How is MCLR calculated?
    • MCLR is determined internally by the bank depending on the period left for the repayment of a loan.
    • MCLR is closely linked to the actual deposit rates and is calculated based on four components:
    • the marginal cost of funds
    • negative carry on account of cash reserve ratio
    • operating costs
    • tenor premium.
  • Under the MCLR regime, banks are free to offer all categories of loans at fixed or floating interest rates.
  • The actual lending rates for loans of different categories and tenors are determined by adding the components of spread to MCLR.
  • Therefore, the bank cannot lend at a rate lower than the MCLR of a particular maturity for all loans linked to that benchmark.
  • Banks review and publish MCLRs of different maturities, every month. 
  • Certain loan rates, like those of fixed-rate loans with tenors above three years and special loan schemes offered by the government, are not linked to MCLR.

What is the difference between MCLR and Base rate?

  • MCLR is an advanced version of the base rate.
  • The base rate is the minimum rate of interest set by the RBI; no financial institution can lend at an interest rate below the base rate.
  • MCLR is an internal benchmarking system applied by a financial institution, under which they can set their own lending rates considering a spread factor.
  • The base rate is based on the average cost of funds, but the MCLR is based on the marginal or incremental cost of money.
  • The base rate does not get impacted by the revision of RBI’s repo rate, while MCLR gets impacted as and when RBI revises the repo rate.
  • Usually, the minimum rate of return or profit margin is taken into consideration while deriving the base rate. While determining the MCLR, the tenor premium is taken into consideration.

Q1) What is the cash reserve ratio (CRR)?

CRR is the percentage of a bank's total deposits that it needs to maintain as liquid cash. This is an RBI requirement, and the cash reserve is with the RBI. A bank does not earn interest on this liquid cash maintained with the RBI and neither can it use this for investing and lending purposes.

Source: Loan EMIs to rise! SBI hikes MCLR by up to 10 basis points