Marginal Cost of Funds Based Lending Rate updated Sep, 2023

 

The full form of MCLR is Marginal Cost of Funds Based Lending Rate. MCLR in simple words, is a new method introduced by RBI which has replaced 'base Rate.' The Base Rate was introduced by RBI in 2010 to regulate the lending systems by the banks. This rate was in form until March 2016 after which it was revoked. From 1st April 2016, the RBI made it compulsory for all banks to make marginal Cost of funds based lending rates. This ensured that interest rates for different types of customers would be fixed. This change will apply to customers who wish to lend money from the bank. The MCLR would not calculate the rate of interest that will be charged to them by the bank.

How MCLR works?

A detailed format of guidelines associated with MCLR is given below:

1. Banks ought to have a Board endorsed approach depicting the segments of spread charged to a client. The strategy might incorporate standards:

• To decide the quantum of every segment of spread.
• To decide the scope of spread for a given classification of borrower/sort of advance.
• To delegate powers in case of advance (loan) pricing.

2. For consistency in these segments, all banks might receive the broad features of spread:

A. Business Strategy
The segment will be touched base at contemplating the business methodology, market rivalry, installed alternatives in the credit item, showcase liquidity of the advance and so forth.

B. Credit Risk Premium
The credit risk premium charged to the client speaking to the default risk emerging from loan given should be touched base on a suitable loan risk rating/scoring model and subsequent to mulling over client relationship, expected misfortunes, insurances, and so on.

i. The spread charged to a current borrower ought not be expanded with the exception of because of decay in the credit risk premium of the client. Any such choice with respect to change in spread by virtue of progress in credit risk profile ought to be upheld by an undeniable danger profile audit of the client.

ii. The stipulation contained in sub-section (iii) above is, notwithstanding, not relevant to credits under consortium/various saving money game plans.

C. Interest Rates on Loans

i. Real loan rates will be controlled by adding the parts of spread to the MCLR. As needs be, there will be no loan beneath the MCLR of a specific development for all advances connected to that benchmark

ii. The reference benchmark rate utilized for valuing the credits ought to frame part of the terms of the advance contract.

D. Exemptions from MCLR

i. Credits secured by plans extraordinarily figured by Government of India wherein banks need to charge loan fees according to the plan, are exempted from being connected to MCLR as the benchmark for deciding financing cost.

ii. Working Capital Term Loan (WCTL), Funded Interest Term Loan (FITL), and so on allowed as a component of the correction/restructuring bundle, are exempted from being connected to MCLR as the benchmark for deciding financing cost.

iii. Advances allowed under different renegotiate plans defined by Government of India or any Government Undertakings wherein banks charge interests at the rates recommended under the plans to the extent refinance can be provided are exempted from being connected to MCLR as the benchmark for deciding loan cost. Interest rate charged on the part not secured under renegotiate ought to stick to the MCLR rules.

iv. The following types of advances or loans can be estimated without being connected to MCLR as the benchmark for deciding loan fee:

(a) Advances to banks' grantors against their own depositors.

(b) Advances to banks' own workers including resigned representatives.

(c) Advances allowed to the Chief Executive Officer/Whole Time Directors.

(d) Loans connected to a market decided outside benchmark.

(e) Fixed rate advances conceded by banks. However, in case of hybrid loans, some of the interest rates are fixed and some are floating. Interest on floating rates should follow the MCLR criterion.

E. Review of MCLR

i. Banks might audit and distribute their Marginal Cost of Funds based Lending Rate (MCLR) of various developments consistently on a pre-decided date with the endorsement of the Board or whatever other advisory group to which powers have been appointed.

ii. In any case, banks which don't have satisfactory frameworks to do the audit of MCLR on a month to month premise, may survey their rates once a quarter on a pre-declared date for the first year, i.e. up to March 31, 2017. From there on, such banks ought to embrace the month to month audit of MCLR as specified in (i) above.

F. Reset of Interest Rates

i. Banks may fix interest reset dates on their floating rate advances. Banks will have the alternative to offer advances with reset dates connected either to the date of assent of the advance/credit confines or to the date of survey of MCLR.

ii. The Marginal Cost of Funds based Lending Rate (MCLR) persistent on the day the credit is authorized will be relevant till the following reset date, independent of the adjustments in the benchmark amid the interval.

iii. The tenure of the reset should be one year or lower. The definite periodicity of reset might make part of the terms of the loan or advances' contract.

G. Treatment of loan costs connected to Base Rate charged to existing borrowers

i. Existing advances and credit limits connected to the Base Rate may proceed till reimbursement or restoration.

ii. Banks will proceed to survey and distribute Base Rate as up to this point.

iii. Existing borrowers will likewise have the choice to move to the Marginal Cost of Funds based Lending Rate (MCLR) connected advance at commonly adequate terms. Howbeit, this ought not be dealt with as a dispossession of existing service.

H. Time outline for implementation

So as to give adequate time to every one of the banks to move to the MCLR based evaluating, the viable date of these rules is April 1, 2016.

Comparatively, a person who applies for a house loan would gain a profit of 10 base points on the rate of interest given that MCLR is charged on him instead of the earlier base rate. The new policy will ensure that the change in the rates by RBI are passed on to the customers so that they can benefit from the revisions. Also, MCLR is believed to bring in more transparency in the operation of banks and their lending rates. This will also enhance the growth of the economy as internal competition amongst the banks would increase wherein they would want to provide the best of the services to their customers. One thing to note here is that customers who had already borrowed loans before the implementation of MCLR will continue to be charged as per the base rate. Actual deposit rates are related to the MCLR. Banks will have the option of choosing the rate for a prolonged time as well, i.e. two to three years. Also, they will need to set at least 5 types of rates which are overnight, one-month, three-month, six-month and one-year. These are the 5 rates which are varied because of difference in time over which they range from one day to one year. MCLR is composed of 4 factors that are listed below:

1. Tenure Premium
2. Negative carry in maintaining CRR
3. Marginal Cost of Funds
4. Operational Costs of bank.

MCLR Calculation

There are 4 criteria to be evaluated for an enhanced understanding of how MCLR works:

1. Tenure Premium: This simply implies that the length of loan is directly proportional to the amount of premium to be paid. For one residual tenor, this will remain the same.
2. Negative carry in maintaining CRR with RBI: CRR means the cash reserve ratio or the amount of cash that is reserved by the banks. This amount can not be used by the banks for its daily purposes. This amount is submitted to the RBI as a token of safety. The CRR is inversely proportional to the amount of money with the bank to be used for lending and investment purposes. The only reason for CRR is to regulate liquidity and ensure safety in the banking system.
3. Marginal Costs of Funds: This heading consists of three sub-headings: (i) Interest charged by the bank to its customers on deposits. (ii) Rate of interest that RBI charges to banks for borrowings (iii) Net worth rate of return 92% weightage is provided to (i) + (ii) and 8% is provided to (iii.)
4. Bank's Operating Cost: It includes the daily utility actions of the bank. It is evident that MCLR is largely dependent on the marginal cost of funds. It is also dependent on the repo rate and a variation in this rate should also bring a change in MCLR. This was the strategy that Dr. Raghuram Rajan suggested so that a decrease in the rate interests would mean that the customers would directly benefit.

Differences between MCLR and BLR

There are several differences between the two lending rates, important of them being mentioned below:

1) Transparency: The loan pricing system is more transparent for MCLR than for BLR, because of the computing formula.

2) Components: There is a difference in components that make up the two rate types. (i) BLR consists of funds, CRR, margin, and the operating expenses. (ii) MCLR has relatively more components and this is what makes it more transparent and varied. It comprises the four factors already discussed: CRR, operating cost, tenor premium and marginal cost of funds.

3) Revision: RBI keeps revising the rate charged on loans on the basis of economic benefits or discrepancies. MCLR is to be reviewed every month whereas the base rate has to be announced by RBI every quarter. The decision whether to choose base rate or MCLR lies with time. Once a loan payer changes the type of loan from base rate to MCLR, the revert can not be done. However, one can easily and anytime change the interest type from MCLR to base rate. MCLR may seem lucrative to the house buyers immediately because basis points are lower in banks for MCLR than Base Rate.

Why should one go for MCLR?

MCLR is a lending system that will keep the rate in sync even when there are fluctuations in the economy. The reason why one should go for MCLR is that when rate cuts happen, more benefits are directly passed on the loan takers, whereas, in the case of a hike, base lending rate customers benefit. If there is a decrease in the rates by the RBI then a person following MCLR benefits in either of the two ways:

(a) The EMI goes down: This is the first option that can happen. A person can save on his monthly premium amount paid to the bank as the rate cut benefits him directly.

(b) Loan tenure comes down: This is another option that can happen in case of a decrease in rates by the RBI. The benefit will be more if one's loan tenure is long.

After the incoming of MCLR, banks some banks have chosen to set a tenor of 1 year for the home loans, some have decided for a tenor of 6 months. For better understanding, you need to gauge that time will give a better answer as to if there are any backlashes to be faced for changing to MCLR.

A few factors to be considered:

(1) The tenor of MCLR will be chosen by one's bank. This will hold true for home and mortgage loans. The reset period can be different as chosen by the bank, -monthly, quarterly, half-yearly or annually.

(2) Base rates are higher than MCLR; a difference of .1% to .2% roughly.

(3) MCLR follows a complex mechanism where banks get some flexibility. This flexibility could be wrongly used by them to charge rates for different pricing. Yet, MCLR is expected to benefit the customers. When base rate was introduced, it was noticed that banks were reluctant to pass the benefits to customers when rates were reduced. However, they were generous in increasing the rates immediately whenever a rate hike was announced. So, the reason is simple, one can consider shifting to MCLR for getting the leverage of rate cuts, but in case of hike, base rate may be more useful. Also, one should check about the tenor of loan and its reset time as suggested by one's bank.

Impact of MCLR on Banks and Lending Institutions

The impact of MCLR on banks is an interesting area of concern. For this, it is important to understand that banks operate by two ways:

1. Lending Money
2. Keeping Deposits

These two systems formulate the working of banks. The banks try to keep the maturity dates of deposits and loans in sync so as to keep the speculated interest rate movements after, say 10 years under control and management. With the introduction of MCLR, short-term interest policies of banks would change. This is how MCLR will impact the banks and lending institutions. This would cause a change in NIM of a bank. A decrease in NIM of a bank would increase its interest rate risk. For floating rate loans and hybrid loans, RBI has asked banks to apply MCLR. Here, loans will have to be generated through funds flowing in through deposits, which would have a different maturity rate. This will leave banks in a position where there NIM will be in compromise. The non-banking finance companies (NBFCs) will relate your rate of interest to retail prime lending rate and not the MCLR.

Impact of MCLR on Borrowers

As already discussed, MCLR has a benefit when rate cuts are announced. This will mean that banks will no longer have the option of keeping the rate cuts benefits in their pocket. They would no longer be able to give an excuse of preparing for resistant times. Therefore, this is how borrowers would benefit. However, it is noteworthy to mention that MCLR would not apply to all kinds of rates of lending. The rate of interests for loans processed based on Government schemes would still continue to follow the rates as suggested by a particular loan scheme. The MCLR covers loans like home loans, property loans and some corporate loans. Personal loans like business loans or vehicle loans would not come under the umbrella of MCLR. Also, CIBIL Score and loan tenor would define the rate of interest as suggested by the banks. These two factors would decide the spread over MCLR.

Should borrowers shift to MCLR System for Loans?

The customers who want to avail home loans or other loans that come under MCLR will have to pay according to the MCLR rate only. Borrowers must understand that there is a spread over which the MCLR would be calculated which would vary for different types of customers. They must gauge whether the spread they fall in would suit them or not. However, if previous loan payers want to update their rate type to MCLR, they will have to ask the bank to do the same. This can happen in two ways:

(1) The borrower can ask for a change in rate type and ask for the rate of interest to be altered immediately. Then, the customer will have to pay a processing fee for the same. If the borrower is not ready to pay the processing fee, rate of interest would be same as the base rate, however after one year it would change to MCLR.

(2) In the second case, the borrower can pay the conversion fee and get immediate benefit of the reduced rate of interest by switching over to MCLR.

The MCLR covers loan like 0.50% of the current principal amount which is the fee charged by the banks to let a switch from base rate to MCLR happen. Other extra costs will also apply, i.e. the administrative costs. Borrowers can ask banks to help them in getting rid of an extra burden of switching costs and the administrative costs. For this banks can surely avoid some of the charges included in the administrative charges. Also, one can negotiate with the banks over the spread of MCLR. Chief executive officer and co-founder, BankBazaar.com said that a person should make a choice of shifting the loan only if the change is for some considerable base points, say 25 and the loan tenor is long. However, it would not be advisable to get the rate type changed if the difference is only of 10 base points.

RBI’s take on MCLR

RBI's take on MCLR has been very clear. Over the past years, RBI drops the rates expecting the banks to pass benefits to the borrowers. But, this advantage does not quite reach the loan payers. With MCLR, RBI gets a surety that rate cuts would be profit the customers. But still, banks would decide the spread over MCLR. With this, RBI tends to promote new borrowers to do a research analysis in the market and find out the bank that offers the the lowest MCLR rate, by looking at the processing charges and the administrative prices to be incurred. RBI has admitted that the rate cuts have not reached the borrowers completely. A rate cut of 50 to 60 basis points has given to the customers an advantage of maximum 30 basis points. This observation was made after two months of implementation of the MCLR. This goes down to the fact that spread component is added basis the risk associated with a borrower's profile. lack of credit demands has also lead to a slow transfer of benefits to the borrowers.

RBI’s Key Guidelines on MCLR

RBI issued key guidelines for the conduction of MCLR as the benchmark for deciding interest rates:

1) Fixed rate loans of a tenor of up to three years would be treated under Marginal Cost of Funds based Lending Rate. Loans with the tenure beyond three years would be exempted from MCLR.

2) Banks will have the provision of computing the outstanding balances prior to at least 7 working days from which the new MCLR becomes effective. The time lag should not be less than one year.

3) Banks will have to publish the tenors for different MCLRs. The tenor of the annex must comprise of funds in the biggest maturity section and must be higher than 30% of the funds calculated. If it is lower then the tenor of 2 or more maturity buckets must be greater than 30% of the funds annexed.

4) The date of initial disbursement would decide the implementation date of the MCLR. The future reset dates shall then be decided.