What is the MCLR Rate and How Does it Affect Loans?

Posted on Monday, April 22nd, 2024 | By IndusInd Bank

What is the MCLR Rate?

The Marginal Cost of Funds based Lending Rate full form of MCLR is an important interest rate set by India’s central bank, the Reserve Bank of India (RBI). It helps banks decide the minimum interest rate for lending money to borrowers. MCLR considers factors like the cost of funds, operating expenses, and statutory reserves. Banks use MCLR as a reference rate to determine loan prices.

Changes in the MCLR can affect your home loan or personal loan EMI. However, your credit score and loan duration also influence the interest rate you receive.

Why was the MCLR Rate Introduced?

MCLR was introduced to make lending fair and transparent in India. Before MCLR, banks used the Base Rate system, which didn’t always reflect changes in borrowing costs accurately. MCLR, based on actual fund costs, allows banks to adjust lending rates quickly to economic changes, benefiting borrowers and managing risks better.

What is the Base Rate?

The meaning of Base Rate is the minimum interest rate banks set for lending. It serves as a starting point for loan interest rates, considering fund costs, operating expenses, and profit margins. Before MCLR, the Base Rate was the primary benchmark for loan rates.

Also Read: Understanding Personal Loan Interest Rates

MCLR versus Base Rate

The transition from Base Rate to Marginal Cost of Funds based Lending Rate MCLR brought significant changes in how banks determine their lending rates. Here are some of the top benefits:

• Calculation Method: Base Rate relies on average costs, while MCLR considers marginal costs.
• Review Frequency: MCLR rates are reviewed more frequently than the Base Rate, allowing quicker adjustments.
• Transparency: MCLR offers greater transparency than Base Rate.
• Impact on Borrowers: MCLR leads to quicker changes in loan rates, affecting borrowers differently.

How Does One Calculate MCLR?

Calculating MCLR in India involves considering several factors to determine the minimum lending rate for banks. Here’s how it works:

Marginal Cost of Funds:

Banks calculate the marginal cost, which includes the cost of various types of funds such as savings deposits, term deposits, and borrowings.

Operating Expenses:

Banks factor in their operating expenses, which include administrative costs, salaries, and other overheads associated with lending operations.

Tenor Premium:

The tenor premium reflects the additional cost banks incur for lending money over longer periods. It’s added to the marginal cost to determine the MCLR.

Cost of Borrowings:

Banks consider the cost of borrowing funds from other sources, such as interbank borrowings and market borrowings, which influences their overall cost of funds.

Repo Rate Changes:

Banks also incorporate changes in the repo rate set by the Reserve Bank of India RBI, as it impacts the cost of borrowing money from the RBI, affecting their overall cost of funds and, consequently, the MCLR.

Frequent Checks, Thorough Reviews and Revisions

It is worth noting that the MCLR is checked and updated regularly by the Reserve Bank of India RBI.

Every so often, usually monthly or quarterly, the RBI looks at various factors such as the cost of borrowing money, the expenses banks have, and changes in the economy. Based on all these things, they decide if the MCLR needs to be changed or updated.

What Does MCLR Aim to Achieve?

Here are the five main aims of the Marginal Cost of Funds based Lending Rate in India:

• Transparency: MCLR aims to make the process of setting lending rates by banks more transparent and understandable for customers.
• Fairness: It wants to ensure that lending rates are fair and based on current market conditions, reflecting changes in the economy and the cost of funds for banks.
• Responsive to Market Changes: MCLR’s goal is to make lending rates more responsive to changes in the economy, allowing for quicker adjustments to factors like the repo rate set by the Reserve Bank of India RBI and other market conditions.
• Efficiency: It aims to promote efficiency in the banking system by encouraging banks to manage their funds more effectively and pass on benefits to borrowers in a timely manner.
• Risk Management: MCLR was introduced to help banks manage risks associated with lending by ensuring that lending rates are sensitive to factors such as credit risk and liquidity risk.

Also Read:  5 Important Personal Loan Factors You Should Consider

On a Concluding Note

Marginal Cost-Based Lending Rate (MCLR) introduced by the Reserve Bank of India (RBI) signifies a major shift towards a fair, transparent and workable lending environment in India where we will expose lending rates to the market conditions have been fairly disclosed By improving transparency, fairness, efficiency and better risk management, MCLR not only helps borrowers and banks but also offers an opportunity to consider offering personalized loans financial needs have played a role in this evolving situation.

If you are looking for a personal loan to achieve your financial goals, you can apply for it with IndusInd Bank today!

Disclaimer: The information provided in this article is generic in nature and for informational purposes only. It is not a substitute for specific advice in your own circumstances. Hence, you are advised to consult your financial advisor before making any financial decision. IndusInd Bank Limited (IBL) does not influence the views of the author in any way. IBL and the author shall not be responsible for any direct/indirect loss or liability incurred by the reader for making any financial decisions based on the contents and information.