Table of Contents
Marginal Cost of Funds Based Lending Rate
MCLR stands for Marginal Cost of Funds Based Lending Rate. It is the benchmark interest rate that commercial banks in India use to determine the lending rates for various loan products. Introduced by the Reserve Bank of India (RBI) in 2016, MCLR replaced the earlier base rate system.
Read about: Indian Financial System
Need of MCLR
The need for MCLR (Marginal Cost of Funds Based Lending Rate) can be understood from the following points:
MCLR brings transparency to the lending rates offered by banks as it is based on the actual cost of funds for the bank. It helps borrowers understand the factors influencing their loan interest rates.
MCLR allows for quicker transmission of changes in policy rates set by the central bank to the lending rates offered by banks. This ensures that borrowers can benefit from rate cuts faster and also reflects changes in the cost of funds more accurately.
MCLR encourages competition among banks as they have to revise their lending rates more frequently. This leads to better interest rates and terms being offered to borrowers.
MCLR provides different tenors (e.g., overnight, monthly, quarterly, etc.) to link loan products, allowing borrowers to choose a loan with an interest rate reset frequency that suits their preferences and expectations.
Alignment with Market Conditions
MCLR takes into account the marginal cost of funds for the bank, which reflects current market conditions. This ensures that the lending rates are more aligned with prevailing market rates.
Better Transmission to End Borrowers
MCLR promotes the more efficient transmission of monetary policy changes to the end borrowers, aiding in effective control of inflation and fostering economic stability.
MCLR vs Base Rate
The difference between MCLR and Base Rate can be understood from the following table.
|MCLR (Marginal Cost of Funds Based Lending Rate)
|Based on the bank’s marginal cost of funds
|Based on average cost of funds
|Periodically reviewed, typically monthly
|Reviewed at the bank’s discretion
|Faster transmission of policy rate changes
|Slower transmission of rate changes
|Interest Rate Reset
|Linked to different tenors (e.g., overnight, monthly, quarterly)
|Typically reset annually or at the bank’s discretion
|Provides transparency in lending rates
|Lacks transparency in rate setting
|Offers flexibility with different tenors
|Offers limited customization options
|Promotes competition among banks
|Less competitive due to lack of frequent revisions
|Reflects current market conditions
|May not always align with market rates
Read about: Payment Banks
Calculation of MCLR
MCLR (Marginal Cost of Funds Based Lending Rate) is calculated by taking into account the following components:
Marginal Cost of Borrowing (MCOB)
This includes the interest paid on new deposits and borrowing from various sources, such as other banks, interbank markets, and market instruments like bonds.
Negative Carry on Cash Reserve Ratio (CRR)
CRR is the portion of deposits that banks are required to maintain with the central bank. Banks do not earn interest on this amount, so the cost of maintaining CRR is factored into the MCLR calculation.
These are the costs incurred by banks in conducting their regular business operations, including administrative expenses, staff salaries, overheads, and other operational costs.
A premium is added to the MCLR based on the tenor (or term) of the loan. Longer-term loans may have a higher premium to account for the increased risk and costs associated with longer tenors.
Marginal Cost of Funds
It is the weighted average cost of borrowing for the bank, taking into consideration the proportions of different sources of funds and their respective costs. The marginal cost is typically calculated based on the current cost of funds and the proportion of various sources in the bank’s funding mix.
Once these components are determined, the bank calculates the MCLR by adding the components together. The exact formula for calculating MCLR may vary slightly from bank to bank, as each bank may have its own methodology and internal guidelines for determining the MCLR. It is important to note that the MCLR is reviewed periodically, usually on a monthly basis, to reflect changes in the cost of funds for the bank.
Read about: Private Sector Banks
Understanding the concept of MCLR (Marginal Cost of Funds Based Lending Rate) is crucial for UPSC aspirants as it aligns with the UPSC Syllabus. MCLR relates to monetary policy, banking, and financial institutions, which are part of the UPSC economy Syllabus. Reputable UPSC Online Coaching platforms often cover MCLR as part of their curriculum, providing comprehensive knowledge on the topic. Furthermore, MCLR and related concepts can be tested by aspirants by attempting UPSC Mock Test.
Read about: Public Sector Banks