# MCLR

Prior to April 1, 2016, if you went to a bank to get a loan, you'd be charged an interest rate based on a base rate. Unfortunately, the base rate system was not widely considered transparent since it frequently failed to communicate rate-cut benefits to clients on time. The Reserve Bank of India then amended its policy and implemented the MCLR or Marginal Cost of Funds Based Lending Rate.

## What is MCLR - Meaning

In essence, the MCLR (MCLR full form - Marginal Cost of Funds-based Lending Rate) is the lowest interest rate at where a bank can lend to its customers on specific loans. The MCLR is an internal benchmark lending rate used by banks to establish loan interest rates. The Reserve Bank of India implemented the MCLR system in 2016 to improve the transmission of policy rate changes to the lending rates offered to clients by banks.

Banks are mandated to compute their lending rates using the MCLR system, which takes into account the current cost of borrowing, interest paid on deposits, and other factors. This contributes to lending rates being more responsive to changes in the RBI's policy rates and market conditions, resulting in increased transparency and efficiency in the banking system.

## MCLR Interest Rate

The current MCLR rate is mentioned below:

 Bank name 3 years 2 years 1 year 6 months 3 months Overnight SBI Bank MCLR rate 8.70% 8.60% 8.50% 8.40% 8.10% 7.95% Axis Bank MCLR rate 8.95% 8.90% 8.80% 8.75% 8.70% 8.60% ICICI Bank MCLR rate – – 9.20% 9.15% 9.10% 9.00% Bank of Baroda MCLR rate – – 8.55% 8.40% 8.30% 7.90% HDFC Bank MCLR rate 9.05% 8.95% 8.85% 8.70% 8.60% 8.50% IndusInd Bank MCLR rate 8.95% 8.90% 8.60% 8.50% 8.35% 8.25% PNB MCLR rate 8.80% – 8.50% 8.40% 8.20% 8.00%

## How to Calculate MCLR?

The loan duration, or the amount of time a borrower has to pay the loan - is used to compute the MCLR. This tenor-linked benchmark is only internal. By adding the factors spread to this instrument, the bank determines the actual loan rates.

Following a thorough examination, the banks report their MCLR. The same procedure applies to loans with varying maturities, such as monthly or on a predetermined schedule. The 4 major attributes of MCLR are as follows:

a) Duration: The cost of lending varies depending on the length of the loan. The greater the loan's tenure, the greater the danger. To cover risk - the bank would shift the burden to the borrowers by charging a premium. The Tenure Premium is the name given to this premium.

b) Operating Cost: Except for costs recovered independently through service charges, operational expenses include the cost of generating cash. It is thus linked to the provision of the loan product as such.

c) Marginal Cost: The marginal cost of funds is the average rate at which deposits with identical maturities were raised in the preceding period. This expense will be reflected in the bank's accounts as an outstanding amount.

The Returns on the Net Worth and Marginal Cost of borrowing are two components of the marginal cost of financing. The Marginal Cost of Borrowings accounts for 92% of the total, while the Return on Net Worth accounts for 8%. This 8% corresponds to the risk-weighted assets defined by Tier 1 capital for banks.

d) Negative Carry On Account of CRR: When return on CRR balance is zero, the CRR (Cash Reserve Ratio) has a negative carry. When the actual return is less than the cost of the funds, negative carry occurs.

This will have an effect on the necessary Statutory Liquidity Ratio Balance (SLR) - a reserve that every commercial bank is required to keep. It is accounted for negatively because the bank cannot use the funds to generate income or earn interest.

## Guidelines of MCLR

The RBI has issued the following MCLR guidelines:

• The MCLR should be reset at least once a year. This must be done even if the marginal cost of funds has not changed.
• Banks are permitted to review and adjust their MCLR once every month.
• The revised MCLR will go into effect on the first of the next month.
• The MCLR has no bearing on house loans with fixed interest rates. For house loans with floating interest rates, the MCLR on the day the loan is sanctioned is used until it is reset.
• The MCLR must be displayed on the banks' websites as well as in their branches.
• If a bank lacks sufficient data on its marginal cost of funds, it must compute the MCLR using the RBI's benchmark deposit rate for that particular duration.

## Difference Between Base Rate and MCLR

Banks determine MCLR based on the structure and technique used. To summarise, this adjustment will benefit borrowers. The MCLR is an enhanced version of the base rate.

The final loan rate for borrowers is determined using a risk-based strategy. It takes into account unique elements such as the marginal cost of funds rather than the overall cost of funds. The repo rate, which was not included in the base rate, is factored into the marginal cost.

Banks are required to include all types of interest rates that they pay when mobilizing funds when computing the MCLR. Before, the loan tenure was not considered while setting the base rate. Banks are now obligated to include a tenor premium in the case of MCLR. This will enable banks to charge greater interest rates on long-term loans.