If you have ever applied for a loan before, chances are that you have heard about MCLR-based rates. MCLR means Marginal Cost of Funds Based Lending Rate. It is the minimum rate of interest a bank can levy for a loan.
The MCLR rate was introduced to help people borrow different types of funds and benefit from rate changes by RBI. This rate ensures that an institution does not charge an interest rate higher than that allowed by the central bank.
The Purpose of MCLR
MCLR was introduced in India as an attempt to realize the effects of the repo rate and pass the benefits to customers. With the MCLR rate, banks are expected to be transparent while deciding the simple interest or compound interest for borrowers.
Banks are also required to pass on the benefits of reduced rates to customers quickly to let them save on their interests and EMIs.
With the implementation of MCLR, banks can provide different types of loans on fixed as well as floating compound interest rates. A bank cannot lend at a rate lower than MCLR except in few cases allowed by the RBI.
MCLR is based on factors like marginal cost of funding, tenor premium, negative carry-on cash reserve ratio, and operating cost.
Difference Between Base Rate and MCLR Rate
While the base rate is set by the RBI, the MCLR rate is defined by banks which means borrowers can find loans at attractive compound interest rates.
The base rate is updated quarterly but the MCLR rate gets updated every month. These changes affect the simple interest and compound interest on loans borrowed.
Loan tenor plays no part in deciding base rate but banks consider tenor for MCLR rate. This leads banks to levy a higher rate of interest with longer tenure.
MCLR is overall an improvised version of the base rate used earlier. It aims to streamline how banks charge an interest rate on different types of loans.
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