Marginal Cost Based Lending Rate (MCLR)

Introduction

• Marginal Cost of Fund based Lending Rate (MCLR) refers to the minimum interest rate a bank must charge for lending. The bank cannot grant any loan below that rate, except in certain cases permitted by the Reserve Bank of India (RBI).
• MCLR serves as a benchmark and was introduced to counter the base rate system. 
• All the categories of domestic rupee loans and for every single loan, irrespective of the category, are governed by MCLR.

Significance of MCLR

• MCLR is determined by the current cost of funds, in contrast to the base rate, which is governed by the average cost of funds. 
• MCLR was introduced by the RBI because rates based on this system are more receptive to the changes in the policy rates. This also ensures that the country’s monetary policy is implemented effectively across all spheres.
• MCLR ensures that the lending rates of banks reflect the policy rates. Moreover, it also provides transparency in the procedure followed by banks to arrive at interest rates on advances.

Factors that Determine the MCLR

In economics, the term ‘marginal’ refers to a specific change in quantity in its current state. Hence, the MCLR takes into account the current cost or incremental cost of funds. Factors which determine the MCLR.

• Marginal Cost of Funds: It comprises marginal cost of borrowings, along with return on net worth. The marginal cost of borrowings holds 92 percent influence, while the other component holds only 8 percent. It also depends on the repo rate and the interest rates charged by banks.
• Operating Costs: These costs are associated with providing the loan, raising funds, and running the day to day operations.
• Cost of Carry in the Cash Reserve Ratio (CRR): The banks have to take into consideration the cash deposits they need to keep with the Reserve Bank of India.
• Tenor Premium: This is essentially the premium that will be charged for long-term loans to mitigate the risk associated with long-term lending.

Important Note: Every month, banks may publish the internal benchmark (MCLR) for overnight, one-month, three-month, six-month and one year maturities.