The Marginal Cost of Lending Rate (MCLR) is the minimum interest rate below which a bank cannot lend money to its customers. Introduced by the Reserve Bank of India (RBI) in April 2016, MCLR replaced the earlier Base Rate System to make loan rates more transparent and responsive to policy rate changes.
The MCLR ensures that the benefits of changes in the RBI’s policy rates, such as the repo rate, are passed on more quickly to borrowers. It directly impacts home loans, personal loans, and other credit facilities offered by banks.
What is MCLR?
The Marginal Cost of Lending Rate (MCLR) is an internal benchmark rate set by commercial banks to determine the interest rates on different types of loans. It represents the cost incurred by the bank for arranging funds and includes components like the repo rate, marginal cost of funds, operating costs, and the tenor premium.
In simple terms, MCLR is the minimum rate below which a bank cannot lend money, except in certain cases like loans against deposits or government schemes. It aims to make lending rates more dynamic, fair, and aligned with market conditions.
Components of MCLR
The calculation of MCLR is based on several key components that reflect the bank’s actual cost of funds and lending operations.
| Component | Description |
| Marginal Cost of Funds | Refers to the interest rate paid by banks on deposits and borrowings. |
| Negative Carry on CRR | The loss a bank incurs due to maintaining cash reserves with the RBI that do not earn interest. |
| Operating Costs | Administrative and transaction costs related to lending operations. |
| Tenor Premium | Additional charge to cover the risk of lending for a longer period. |
Each bank calculates MCLR based on these factors, ensuring that the rate reflects the bank’s true cost of lending.
Types of MCLR
Banks publish different MCLR rates depending on the tenure of the loan. This helps determine the interest rate for different loan types and repayment durations.
| Tenure | Type of MCLR |
| Overnight | For short-term borrowing (1 day) |
| One Month | For loans with a 30-day reset period |
| Three Months | For loans reset every 3 months |
| Six Months | For loans reset every 6 months |
| One Year | For long-term loans like housing or business loans |
The most common reset period for housing loans in India is one year. This means the loan interest rate gets reviewed annually according to the latest MCLR.
Objectives of Introducing MCLR
The RBI introduced the MCLR system to improve the transmission of monetary policy and bring transparency to the lending process. It ensures that borrowers benefit when the RBI reduces its policy rates.
| Objective | Description |
| Transparency | Makes lending rate calculation more open and standardized. |
| Efficiency | Links lending rates to the actual cost of funds. |
| Monetary Policy Transmission | Ensures RBI rate changes affect bank lending rates promptly. |
| Fair Borrowing Cost | Provides borrowers with interest rates that reflect current market conditions. |
| Reduced Discretion | Limits arbitrary rate-setting by individual banks. |
MCLR vs Base Rate
Before the introduction of MCLR, banks followed the Base Rate System, which was less responsive to policy rate changes. MCLR offers better transparency and flexibility.
| Basis | MCLR | Base Rate |
| Implementation Year | 2016 | 2010 |
| Basis of Calculation | Marginal cost of funds | Average cost of funds |
| Transparency | High | Moderate |
| Policy Rate Transmission | Faster | Slower |
| Frequency of Review | Monthly | Quarterly |
| Impact on Borrowers | Quicker benefits when rates fall | Delayed benefits when rates fall |
The MCLR framework thus ensures that loan rates move more closely in line with the RBI’s repo rate changes.
How MCLR Affects Borrowers?
For borrowers, MCLR directly determines the interest rate on loans like housing, personal, education, and vehicle loans. When banks reduce their MCLR, existing borrowers benefit from lower EMIs (if their reset date arrives), and new borrowers get loans at cheaper rates.
However, if MCLR rises, loan EMIs also increase. Therefore, MCLR links a borrower’s loan cost directly with economic and market conditions, making lending more transparent and fair.
Frequently Asked Questions (FAQs)
Q1: What does MCLR stand for?
A1: MCLR stands for Marginal Cost of Lending Rate. It is the minimum interest rate below which a bank cannot lend, ensuring transparency in loan pricing.
Q2: Who decides the MCLR rate?
A2: Each commercial bank in India determines its own MCLR based on RBI guidelines, considering factors such as the cost of funds, operating expenses, and risk premiums.
Q3: How often is MCLR reviewed by banks?
A3: Banks generally review and publish their MCLR rates once every month, ensuring they reflect current market and monetary conditions.
Q4: How does MCLR affect loan EMIs?
A4: When a bank reduces its MCLR, the interest rate on linked loans decreases, leading to lower EMIs. Conversely, if MCLR rises, EMIs increase.
Q5: What is the difference between MCLR and EBLR?
A5: MCLR is based on a bank’s internal cost of funds, while EBLR (External Benchmark Lending Rate) is linked to an external benchmark like the RBI repo rate, making rate transmission faster and more direct.
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