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What Is MCLR? Here’s A Guide to MCLR

MCLR rates

The RBI (Reserve Bank of India) has set a fixed internal rate for banks. The interest rate is then used by the lending institutions and banks that come under the RBI to define the minimal rate of interest applicable to distinct loan kinds. This rate is updated by the RBI occasionally at the time when there is a tremendous change in the economic activities of the country. Usually, banks are not permitted to lend money at a rate less than the MCLR rates if the applicant avails fixed interest rate regime for the loan. 

Learn more regarding MCLR Rates, their implementation, and how it is distinct from the base rate. 

What is meant by MCLR rates?

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The full form of MCLR is the marginal cost of funds-based lending rate is the minimum lending rate below which the lender is not allowed to lend. MCLR replaced the previous base rate to determine the lending rates for the commercial banks. 

The RBI implemented the MCLR rates in 2016 to determine the interest rates for loans. This is an internal reference rate for the banks to decide the interest they charge on loans. They take into consideration the additional or the incremental cost of arranging the additional rupee for the prospective buyer. 

For instance, SBI MCLR Rate was just recently revised on 15th July 2022 – 

Repayment tenureExisting MCLR (in percentage)Revised MCLR (in percentage)
3 years7.707.80
2 years7.607.70
1 year7.407.50
6 months7.357.45
3 months7.057.15
1 month7.057.15
Overnight7.057.15

MCLR implementation outcome – 

After the MCLR rate implementation, the rate of interest is decided as per the relative risk factor of the customers. Earlier, when the RBI reduced the repo rate, banks took an extremely long time to reflect the same on rates for loans. 

As per the regime of MCLR, banks should adjust their rate of interest with the changes in RBI’s repo rate. Such implementations are aimed at ameliorating the openness in structure and allowing banks to compute the rate of interest in advance. Also, it ensures the prospect of bank credits at the interest that is true for the consumers and banks. 

How are MCLR rates calculated?

MCLR is computed based on the loan tenure, i.e., the amount of time within which the borrower must repay the loan. Such tenure-linked benchmark, by nature, is internal. Banks decide the actual rate of lending by including the elements like spread to it. Banks then publish the MCLR post careful analysis. The same procedure applies for the loans of distinct maturities – overnight, 1 month, 3 months, 6 months, 1 year, etc. 

4 major MCLR elements are made up of the listed – 

Tenure premium – 

The lending cost differs based on the loan period. The higher the loan duration, the higher would be the risk. To cover up the risk, banks shift the load to applicants by charging an amount called the premium. Premium is even addressed by the term tenure premium.

The marginal cost of funds – 

The marginal cost of funds refers to the average rate at which deposits with similar maturities were raised in the course of a particular period before the date of the review. This cost reflects in the books of the bank as an outstanding balance. 

The marginal cost of funds has various components, such as the return on net worth and marginal borrowing cost. Marginal borrowing costs take around 92 percent while the return on the net worth computes to 8 percent. This 8 percent is equal to weighted assets risks as denoted by tier one capital for the banks.

Operational cost –

Operational costs involve the cost of raising funds, barring costs recovered separately via service fees. Thus, it is linked with providing loan products. 

Negative carry-on account of cash reserve ratio (CRR) – 

A negative carry-on cash reserve ratio (CRR) takes place when the return on the CRR balance is 0. Negative carry comes up when the actual return is below the cost of funds. This impact the mandatory SLR (statutory liquidity ratio balance) reserve, which every commercial bank should maintain. This is accounted negatively as banks cannot use funds to earn any income nor acquire interests. 

How is MCLR distinct from the base rate?

MCLR is set by banks based on the methodology and structure followed. To summarize, borrowers can benefit from the change. MCLR is nothing but an improved or ameliorated version of the bank’s base rate. 

This is a risk-based approach, which allows for determining the final rate of lending for borrowers. It factors in the unique parameters like marginal cost of funds in place of overall fund cost. Marginal cost considers the RBI’s repo rate and does not form a part of the bank’s base rate. At the time of computing the MCLR, banks consider all types of interest rates they incur for mobilizing the funds. 

Earlier, loan repayment tenure was not factored in when deciding the base rate. In the scenario of the MCLR, banks are now required to add in the tenure premium. This permits banks to charge a higher interest rate for loans with a long-term horizon. 

What is the deadline to disclose the monthly MCLR?

Banks hold the right to make available all loan categories under floating and fixed interest rates. If fixed, it is linked with the MCLR rate, and if floating, it is linked with the newly launched repo rate. Additionally, banks require to follow deadlines to divulge the internal benchmark or MCLR. They can be 1-month MCLR, overnight MCLR, 3 months MCLR, 2 years MCLR, or of any maturity as per the bank. 

The lending rate of the bank cannot be less than MCLR for any maturities. However, there are other loans not linked with MCLR. These involve loans against customers’ deposits, special loan schemes by the Indian Government or Jan Dhan Yojana, loans to bank employees, and fixed interest rate loans with a tenure of over 3 years. 

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