What is MCLR? Understanding Its Meaning and Impact

What is MCLR? Meaning and Definition

MCLR, or Marginal Cost of Funds based Lending Rate, is the minimum interest rate below which a bank in India is not permitted to lend, except in specific cases allowed by the Reserve Bank of India (RBI). Introduced in April 2016, MCLR replaced the earlier Base Rate system to ensure faster transmission of monetary policy and more transparent loan pricing.

The objective of MCLR is to make lending rates more sensitive to policy rate changes, thereby aiming to benefit borrowers whenever RBI cuts repo rates. Unlike the Base Rate and Benchmark Prime Lending Rate (BPLR), which lacked transparency, MCLR ensures that borrowers have a clearer understanding of how their loan rates are determined.

How is MCLR Calculated? Components and Formula

MCLR is calculated using a formula that factors in various components affecting a bank’s cost of lending. The four primary elements are:

- Marginal cost of funds:

Includes the cost of deposits and borrowings for the bank.

- Operating cost:

Expenses incurred to run banking operations.

- Tenor premium:

Compensation for lending risk based on the loan’s duration.

- Negative carry on CRR:

The cost borne by banks as they maintain a cash reserve ratio without earning interest.

Formula: MCLR = Marginal cost of funds + Operating cost + Tenor premium + Negative carry on CRR

For example, if a bank’s marginal cost is 7 percent, operating cost is 0.5 percent, tenor premium is 0.2 percent and negative carry on CRR is 0.1 percent, then MCLR = 7.8 percent. Banks calculate MCLR for different tenors such as overnight, one-month, three-month, six-month, and one-year to suit diverse loan requirements.

MCLR vs Base Rate: Key Differences Explained

The introduction of MCLR was a major step in replacing the Base Rate to ensure better alignment with monetary policy. Below is a comparison of the two systems:

How Does MCLR Impact Loan Interest Rates and EMIs?

MCLR directly affects floating rate loans, where the interest rate changes as per the prevailing MCLR. Any revision in MCLR impacts loan EMIs and overall affordability.

- If MCLR rises, EMIs increase, making loans costlier.
- If MCLR falls, EMIs reduce, offering relief to borrowers.
- Interest rates cannot go below the MCLR for most loans.
- Exceptions include loans against fixed deposits or government-backed schemes.

For instance, if a borrower has a loan of ₹50 lakh at an interest rate of 8 percent linked to a one-year MCLR, and MCLR drops by 0.5 percent, the EMI will reduce significantly, leading to considerable savings over the loan tenure.

Also Read: Home Loan EMI Calculation: Simple Step-by-Step Guide

Types of MCLR Rates by Tenor and Their Use Cases

Banks publish different MCLR rates for various tenors, catering to short-term and long-term loans. The commonly published tenors are:

- Overnight MCLR: Typically used for very short-term borrowing.
- One-month MCLR: Suitable for working capital loans.
- Three-month and six-month MCLR: Often applied to business loans and short-term credit.
- One-year MCLR: Commonly used for home loans, personal loans and MSME loans.

Also Read: What is MSME – Meaning, Full Form & Key Features

The reset frequency, usually ranging from six months to one year, determines when the new MCLR will apply to an existing loan, thereby affecting EMIs.

Why is MCLR Important for Borrowers in India?

MCLR plays a critical role in ensuring fairness and efficiency in loan pricing. For borrowers, it brings several advantages:

- Greater transparency in how loan rates are set.
- Faster transmission of RBI repo rate changes to loan interest rates.
- Better financial planning due to clearer linkage between policy rates and EMIs.
- Enhanced effectiveness of RBI’s monetary policy.

FAQs

Q.1. What is the difference between MCLR and repo rate?

A. The repo rate is the rate at which RBI lends money to banks, while MCLR is the minimum rate at which banks can lend to borrowers. MCLR is indirectly influenced by repo rate movements.

Q.2. How often do banks revise their MCLR rates?

A. Banks review and publish MCLR rates every month.

Q.3. Does MCLR affect fixed-rate loans?

A. No, fixed-rate loans are not linked to MCLR. They remain constant throughout the loan tenure regardless of MCLR changes.

Q.4. Which Indian banks offer the lowest MCLR?

A. MCLR rates vary across banks and tenors. Borrowers should check the latest published MCLR rates on individual bank websites or RBI’s portal.

Q.5. How can I check my loan’s MCLR linked interest rate?

A. Borrowers can check their loan agreements, bank statements or official bank websites to know the MCLR applicable to their loans.

Disclaimer:

The contents of this article are for information purposes only and not a financial advisory. The information is subject to update, revision, and amendment and may change materially. The information is not intended for distribution or use by any person in any jurisdiction where such distribution or use would be contrary to law or regulation or would subject Godrej Capital or its Affiliates to any requirements. Godrej Capital or its Affiliates shall not be responsible for any direct/indirect loss or liability incurred by the reader for making any decisions, financial or otherwise based on the contents and information mentioned. For more information, please visit www.godrejcapital.com.