Smart things to know about MCLR

The Marginal Cost based Lending Rate (MCLR) refers to the bank’s minimum interest rate which cannot be lent. It is a tenor-linked internal benchmark, which means that the rate is determined internally by the bank. It depends on the period left for the repayment of a loan. It actually describes the method of the minimum interest rate for home loans that are decided by a bank – on the basis of marginal cost or the incremental or additional cost of arranging one more rupee to the prospective borrower.

The MCLR methodology for fixing interest rates for advances was introduced by the Reserve Bank of India (RBI) from April 1, 2016. This new methodology took the place of the base rate system introduced in July 2010. In other words, all the rupee loans sanctioned and renewed credit limits would be priced with reference to the Marginal Cost based Lending Rate (MCLR) which will be the internal benchmark for such purposes.

Existing loans and credit limits linked to the base rate used to authorize interest rates until 31 March 2016 or Benchmark Prime Lending Rate (BPLR) to determine the interest rates on advances/loans sanctioned up to June 30, 2010.) would continue till the repayment or renewal, as the case may be. However, existing borrowers will have the option to switch to the Marginal Cost based Lending Rate (MCLR) linked loan at mutually acceptable terms.

Here are some smart things to know about MCLR

  1. MCLR is the new RBI guideline for commercial banks to set lending rates. It has replaced the base rate system.
  1. The marginal cost of funds is a key component in calculating MCLR. Changes in key rates like the repo rate, which alter the marginal cost of funds, will impact MCLR.
  1. Marginal Cost based Lending Rate (MCLR) is a tenure-based benchmark, not a single rate. The Bank publishes at least five MCLR rates across the overnight, one-month, three-month, six-month and one-year tenures.
  1. The final lending rates offered by the banks appear by adding the ‘spread’ to the MCLR rate.
  1. All the floating rate loans are linked to MCLR.
  1. Existing borrowers with loans linked to base rate can continue with them till maturity or they can also switch to the MCLR However, once a borrower opts for MCLR, the process can’t be reversed.

How to calculate MCLR

To calculate MCLR, banks have to take a note of their changed cost conditions. The MCLR rule states various aspects of the marginal cost. An unusual factor is the added interest rate given to the RBI to get short-term funds.

Main Components of MCLR

1)The marginal cost of funds

The marginal cost of funds will consist of the Marginal cost of borrowings and the returns on net worth.

2)Negative carry on account of CRR

This is the cost that the banks have to incur while keeping reserves with the RBI. The cost of such funds kept untouched can be charged from loans given to the people.

3) Operating costs

The operating expenses incurred by the banks is the operating cost.

4) Tenor premium.

Tenor premium denotes that higher interest rate can be charged from long-term loans.

The Base Rate system is not completely outdated. But, the MCLR rate can be a better system in terms of calculating the interest rate. This will ensure that the consumers benefit every time there is a change in the REPO rate. If you’ve availed a loan after 1st April 2016, then it’s automatically linked with the MCLR mode. However, if your loan is taken prior to this date and linked to the base rate regime, you have the option to switch to the MCLR mode. In case of completion of your loan tenor, it’s better to stick with the base rate.