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Marginal Cost of Fund-Based Lending Rate (MCLR)

2022 APR 22

Preliminary   > Economic Development   >   Indian Economy and Issues   >   Banking sector

Why in news?

  • State Bank of India has raised the marginal cost of funds-based lending rates (MCLR) for the first time in three years.
  • As a result, borrowers who have taken home, vehicle, and personal loans will find their equated monthly instalments (EMIs) rising in the coming months.

What is MCLR?

  • MCLR is the minimum lending rate below which a bank is not permitted to lend.
  • MCLR replaced the earlier base rate system to determine the lending rates for commercial banks.
  • The Reserve Bank of India introduced the MCLR methodology for fixing interest rates from 1 April 2016.
  • It is determined by banks internally, depending upon the loan repayment time. The rate varies from one bank to another.
  • It is calculated based on four components:
    • The marginal cost of funds (additional or incremental cost of arranging an additional rupee for a prospective buyer)
    • Negative carry on account of cash reserve ratio
    • Operating costs
    • Tenor premium

The outcome of MCLR implementation:

  • After the implementation of MCLR, the interest rates are determined as per the relative risk factor of individual customers. Previously, when RBI reduced the repo rate, banks took a long time to reflect it in the lending rates for the borrowers.
  • Under the MCLR regime, banks must adjust their interest rates as soon as the repo rate changes. The implementation aims at improving the openness in the structure followed by the banks to calculate the interest rate on advances.
  • It also ensures the prospect of bank credits at the interest that is true to the consumers as well as the banks.

What is the difference between MCLR and Base Rate?

  • MCLR is an advanced version of the base rate. It is a risk-based approach to determine the final lending rate for borrowers. It considers unique factors like the marginal cost of funds instead of the overall cost of funds.
  • The marginal cost takes into account the repo rate, which did not form part of the base rate. When calculating the MCLR, banks are required to incorporate all kinds of interest rates that they incur in mobilizing the funds.
  • Earlier, the loan tenure was not taken into account when determining the base rate. In the case of MCLR, the banks are now required to include a tenor premium. This will allow banks to charge a higher rate of interest for loans with long-term horizons.

Add ons:

  • Loans that are not linked to MCLR includes loans against customers’ deposit, loans to the bank’s employees, special loan schemes by the Government of India (Jan Dhan Yojana), fixed-rate loans with tenures above three years.

PRACTICE QUESTION:

Consider the following statements regarding Marginal Cost of Fund-Based Lending Rate (MCLR)

1. It is the maximum interest rate that a bank can lend at.

2. The rate is fixed by RBI every month

Which of the statements given above is/are correct?

(a) 1 only

(b) 2 only

(c) Both 1 and 2

(d) Neither 1 nor 2

Answer