Understanding the Marginal Cost of Funds-Based Lending Rate (MCLR)

Introduction

• Recently, the State Bank of India (SBI) implemented an increase, up to 10 basis points, in its Marginal Cost of Funds-Based Lending Rate (MCLR) for selected tenures. This move underlines the significance of comprehending MCLR and its role in the lending landscape.

What is MCLR?

• MCLR stands as the minimum lending rate, establishing the lowest threshold at which banks can lend. Its primary objective lies in facilitating the calculation of the minimal interest rate for diverse types of loans offered by banks.

Calculation of MCLR

• Introduced by the Reserve Bank of India (RBI) on April 1, 2016, the MCLR methodology replaced the earlier base rate structure, enhancing monetary policy transmission and fostering transparency in interest rate setting. The determination of MCLR within banks is an internal process influenced by factors like the marginal cost of funds, negative carry due to the cash reserve ratio, operating costs, and tenor premium.

How MCLR Functions

• Under the MCLR regime, banks have the flexibility to offer loans at fixed or floating interest rates. The actual lending rates for different loan categories and tenors are established by adding the spread components to MCLR. This ensures that banks cannot lend below the MCLR for a particular maturity on loans tied to this benchmark. Banks review and publish MCLR rates for various maturities every month, with exceptions for certain types of loans not linked to MCLR.

Differentiating MCLR from Base Rate

• MCLR represents an evolved version of the base rate. While the base rate signifies the minimum interest rate set by the RBI, MCLR operates as an internal benchmarking system within financial institutions. Here are the key distinctions:
• Methodology: The base rate relies on the average cost of funds, while MCLR is rooted in the marginal or incremental cost of money.
• Impact of RBI Policies: The base rate remains unaffected by changes in RBI’s repo rate, whereas MCLR adjusts in response to revisions in the repo rate.
• Rate Determinants: The base rate considers the minimum rate of return, whereas MCLR incorporates tenor premium in its determination process.

Conclusion

• Understanding MCLR, its calculation intricacies, and the disparities from the base rate is pivotal in grasping the dynamics of lending rates. The recent adjustment by SBI underscores the ongoing relevance and impact of MCLR in the financial landscape.