All About Marginal Cost Funds Based Lending Rates-MCLR

What is Marginal Cost Based lending Rate (MCLR)?

Marginal Cost Based lending Rate (MCLR) is the minimum rate of interest below which the bank cannot lend the loan, with an exceptional of certain cases as approved by RBI. MCLR is the internal benchmark or the reference rate based of which bank lends the loan. MCLR describes the method based on which the banks get to know the minimum interest rates at which the loans can be disbursed.
MCLR method for fixing the rate of interest was introduced dated 1st April 2016 by Reserve Bank of India. MCLR has successfully been able to replace the base rate system that was introduced in July 2010. Therefore, all the rupee loans that were sanctioned and the credit limits that were renewed after 1st April will be priced with reference to the MCLR, MCLR being the benchmark for all banks. The lending rates would be then internally decided by the bank based on this benchmark. The credit limit and the loans that have been prevailing before 31st March 2016 will be charged interest based on the Base Rates. Existing clients will have an advantage of opting for MCLR linked loans on terms that can be mutually acceptable by both the customer and the bank.

Enlisted below are various reasons for introduction of MCLR:

The main reason as to why MCLR was introduced was owing to the fact that the rates based on the marginal cost are more sensitive to the changes in policy rates which is very important for implementing monitory policy. Before the introduction of MCLR every bank would follow their own methodology for calculating the base / minimum rated which would be either based on average, or marginal, or blended cost of the funds. MCRL introduced is likely to bring following enhancements:

• Improvise the transmission of policy rates into rates at which the banks would lend.

• To bring transparency in the methods followed by carious banks to determine the rate of interest on advances.

• To ensure that the bank credit is available at interest rates that is fair to both the borrowers and the banks.

• To make banks more competitive and also enhancing the long run value of banks in order to ensure economic growth.

The MCLR comprises of following:

• Marginal cost of funds: Marginal funds comprise of the marginal cost of the amount borrowed and the return on the net worth, weighed appropriately.

Marginal Cost of Fund = (92% * Marginal Cost of borrowed Amount) + (8% * Return on Net-worth)

The fixed weightage of 8% that is given to return on net worth is prescribed as Tier 1 Capital for the bank. Whereas the marginal cost is referred to average rate that which the deposit of similar maturity was raised in a particular period before the date of review, as weighed by the outstanding balance in the bank records. The rates offered on the deposit of similar maturity on date of review or rates at which funds were raised * Balance outstanding as percentage of total funds which is other than equity as on any day, but not more than 7 calendar days prior to date from which MCLR becomes effective.

• Negative carry on account of' Cash reserve ratio (CRR): Negative carry on mandatory CRR arises when the return on CRR balance is nil. Negative carry on mandatory statutory liquidity ratio - also known as SLR balances arise only if actual return there is lower than the cost of fund.

• Operational Cost: Operational cost that is associated with providing the loan includes the cost of raising fund and excluding the costs that are separately covered in any form of service charges.

• Tenure Premium: The tenure premium is never borrower specific or loan class specific and remains uniform for all kinds of loan products for a given residual tenure.

The banks may publish an internal benchmark or MCLR on a monthly basis depending on the maturities which can be Overnight, One-month, Three-months, Six months, One year, MCLR for any other maturity which the bank considers fit. Banks remain free to offer any of the above categories of advances on both fixed as well as floating rate of interests. Banks need to add the components of spreads to MCLR in order to determine the actual lending rate on floating rate advances in all cases. Also, there cannot be any lending below the MCLR of a particular maturity, for any loan that has been linked to benchmark.

Banks have to determine their actual lending rates on floating rate advances in all cases by adding the components of spread to the MCLR. Accordingly, there cannot be lending below the MCLR of a particular maturity, for all loans linked to that benchmark. Fixed rate loans upto three years are also priced with reference to MCLR. Certain Fixed Rate loans having loan tenure of more than 3 years, advances to banks own employees, special loan schemes introduced by the Govt. of India, etc are not linked to MCLR

How is base rate different from MCLR?

Base rates is calculated based on the cost of funds, minimum rate of return which is the margin or profit, the cost for maintaining enough cash reserve ratio and the operational expenditures whereas, the MCLR is based upon the marginal cost of funds, operational expenditure, tenure premium, and maintaining cash reserve ratio. The major between the two is the calculation of marginal cost under the MCRL considering the factors mentioned below:

• Interest rate for various types of deposits

• Borrowings

• Return on Net worth

Therefore the deposit rates and repo rates are the key factors that determine MCLR

How to apply for MCLR?

For customers who have borrowed money from the bank before the 1st April 2016 need not do a thing and the bank they are partnered with will link their loan accounts with MCLR automatically.
For customers who have not opted for base rates need to take a call and decide if they wish to link their accounts to MCLR depending on your ease.

If you pick the former all you need to do is submit a simple hand written application, and your loan account can be shifted to MCLR. However, note that shifting your account from Base rate to MCLR may involve nominal charges such as administrative charges, processing fee, etc.

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