The Complete Guide To Understanding MCLR - Loan Trivia


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Thursday 20 May 2021

The Complete Guide To Understanding MCLR


When it comes to your loan, you may have heard of something called MCLR-based rates. Ever wondered what this is? And how is it likely to impact your finances? Let us try and demystify the world of MCLR with this simple post:

But first, what is the MCLR rate?

MCLR stands for Marginal Cost of Funds Based Lending Rate. MCLR is the minimum rate of interest that a bank is allowed to lend funds at. 

India’s central bank, the Reserve Bank of India (RBI), introduced the MCLR rate in April 2016. It was launched to help borrowers applying for different types of finance, including home loans, take advantage of RBI’s rate changes. 

It was the MCLR rate that replaced the earlier base rate structure, which was active since July 2010. The new MCLR rate ensures that a lender can’t charge you an interest rate on loan beyond RBI’s prescribed margin. 

It is where the understanding of MCLR becomes a must. 

Why was MCLR introduced?

Commercial banks were not ready to modify their lending rates, deposit rates and even periodic changes in repo rate. 

It meant that there was always a major delay between the change announced in the repo rate of RBI and the effects on a customer. 

The repo rate purpose could be realized only when its benefits were passed on to a borrower. It is why MCLR was brought to the scene in India. 

With the introduction of the MCLR rate by RBI, India’s apex bank aimed to: 

  • Come up with the much-needed transparency in financial institutions. It is while deciding their rate of interest for potential borrowers. 

  • Pass on the benefits of lowered interest rate to customers instantly so that they could save on loan interest charges and pay reduced EMIs. 

  • Ensure availability of different types of loans to borrowers fair both to the lender and a customer. 

What led to the implementation of MCLR?

After the implementation of the MCLR rate in India, banks became free to provide all types of loans on floating and fixed interest rates. 

The actual loan’s lending rate of diverse types and tenors can now be determined. It is done after adding elements of spread to MCLR. 

Hence, a bank is not allowed to lend at an interest rate lower than MCLR. Like everything, certain exceptions can also be made if allowed by RBI. 

MCLR is a tenor-oriented internal benchmark. It denotes that the rate is decided internally by a bank as per the tenor left for the loan’s repayment. 

MCLR is based on different factors to widen the usage of this system. 

The four key aspects of MCLR are the tenor premium, marginal cost of funds, operating cost and negative carry on CRR (Cash Reserve Ratio). 

What are the differences between the MCLR rate and the base rate?

MCLR rate and the base rate have a number of differences. Here are some of the most important ones: 

  • RBI sets the base rate, and MCLR is set by banks depending on their business plans. It signifies that a borrower can benefit from attractive compound interest rates and loans at a cheaper rate. 

  • Base rate loans’ rates of interest were updated once in a quarter. MCLR, on the other hand, gets published on a monthly basis. 

  • The tenor of a loan was not considered while determining the base rate. In the event of the MCLR rate, banks are now needed to include a tenor premium. It leads banks to charge a higher loan interest rate with long terms. 

  • The pricing of loans is more transparent in MCLR than the base rate. 

  • MCLR takes into account unique elements such as the marginal cost of funds in place of the overall cost of funds. The former considers the repo rate not forming the part of the base rate. 

Overall, the MCLR rate could be stated as an improved version of the earlier active base rate.

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