Marginal Cost of Funds based Lending Rate (MCLR)

Summary: Understand MCLR, the minimum lending rate set by banks, which replaces the earlier base rate. Learn more about its significance in lending decisions

06 Aug 2021 by IDFC FIRST Bank

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Banks offer you a variety of loans for floating interest rates, which have a direct influence on the MCLR, or Marginal Cost of Funds based Lending Rate. It has gained much significance since its inception on April 1, 2016. Banks determine this “tenor-linked internal benchmark” internally based on the tenor remaining for the repayment of a loan.

What is MCLR?

MCLR is the minimum lending rate below which banks are not allowed to lend. Replacing the base rate, which was the standard lending rate earlier, MCLR is closely connected to the existent deposit rates. It is derived based on the components such as the marginal cost of funds, operating costs, Cash Reserve Ratio (CRR) and Tenure Premium.

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Banks, under MCLR, can offer different types of loans and tenors on lending rates calculated by adding the components used for MCLR calculation. This also includes the incremental or extra cost of having an additional rupee for a prospective loan applicant. Henceforth, banks cannot give loans of a particular maturity at an interest rate lower than this rate. They have to publish this rate on different maturities every month. Here are some objectives of this rate:

Improve the transmission of Reserve Bank of India’s policy rates into the banking system
Have transparency in fixing the interest rates on various loans provided by the bank
Make sure that the interest rates on loans are fair for both the borrowers and banks
Banks enjoy a competitive advantage on loans they give, which in turn contributes to the economic growth of the country.

Effect of MCLR on the economy

The banking system has a major influence on the economy of a country. With the current MCLR rate, banks keep the faith of the borrowers and the business in the banking sector. The transparency maintained in the lending rates through calculations based on the minimum loan rate encourage more and more individuals and businesses to depend on banks for their credit needs.

Through MCLR, there is quicker and more effective transmission of RBI’s policy rates into the banking system, resulting in better monetary policy measures. The interest cut rates from RBI will thus, reduce the EMIs on loan.

Where to find the Minimum Loan Rate?

A bank is required to publish its MCLR rate for various maturities every month according to the regulation from RBI. These maturities may be overnight, fortnight, one month, six months, 12 months, or anything other than these, which a bank would publish. You can find this minimum loan rate on the official website of the bank.

Should you link your loans to MCLR?

If you have a home loan, you do not have to link it; however, for some loans like a travel or vehicle loan, you need to. The MCLR for business loans, home loans, etc., has been replaced by the newly introduced external benchmarking system in October 2019 by RBI. This new lending rate system is applicable for only floating-interest-rate loans, and not for those with fixed interest rates. Furthermore, only banks will apply this new benchmarking system and not the nonbanking financial companies.

As a result, the loans offered by banks under the new system are connected to the repurchasing option (repo) rate or treasury bills offered by the Government of India, which is to promote transparency and efficiency in the banking system. While boosting retail consumption, the current MCLR rate and system helps banks to pass any reduction in interest rates to customers.

You can apply for a home loan at the best interest rates on the IDFC FIRST Bank website here. Using the IDFC FIRST Bank’s home loan EMI calculator, you can calculate your EMI payments for a maximum tenure of 30 years.

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