As a borrower or an investor in the Indian financial market, it is important to understand the key terms and concepts that are used in the lending and borrowing process. One such term that has gained significant importance in recent years is MCLR, which stands for Marginal Cost of Funds based Lending Rate. In this article, we will take a closer look at what MCLR means, how it is calculated, and its impact on borrowers and lenders.
Introduction to MCLR
MCLR or Marginal Cost of Funds based Lending Rate is a benchmark interest rate that is used by banks to determine the interest rate they will charge on loans and advances. MCLR is calculated based on the marginal cost of borrowing for banks, taking into account various factors such as the cost of funds, operating expenses, and negative carry on account of CRR (Cash Reserve Ratio).
Historical Context of MCLR
The Reserve Bank of India (RBI) introduced MCLR as a replacement for the Base Rate system in April 2016. The Base Rate system had been in place since July 2010 and was used as a benchmark for determining the interest rate on loans and advances. However, the Base Rate system had its limitations, including the lack of transparency in the calculation methodology and the slow transmission of changes in policy rates to the end borrowers.
How is MCLR calculated?
MCLR is calculated based on four components:
Cost of Funds
The cost of funds is the average cost at which banks borrow money from various sources such as savings and current account deposits, term deposits, and borrowings from other banks.
Negative carry on account of CRR
Banks are required to maintain a certain percentage of their deposits as Cash Reserve Ratio (CRR) with the RBI. The amount of CRR that banks have to maintain does not earn any interest. This is referred to as negative carry on account of CRR and is factored into the calculation of MCLR.
Operating costs
Operating costs include expenses such as salaries and wages, rent, utilities, and other administrative expenses.
Tenor premium
The tenor premium is the additional cost that banks charge for loans with longer tenors. This is because longer tenor loans are considered to be riskier than shorter tenor loans.
Comparison between MCLR and Base Rate
MCLR is considered to be a more transparent and efficient benchmark compared to the Base Rate system. Under the Base Rate system, banks were allowed to determine their own benchmark interest rate, which led to variations in interest rates across banks. In contrast, MCLR is a uniform benchmark that is calculated based on a transparent methodology.
Benefits of MCLR for Borrowers
MCLR has several benefits for borrowers:
Better Transmission of Policy Rates
MCLR has been designed to ensure better transmission of changes in policy rates to the end borrowers. This means that when the RBI changes the policy rates, the impact is felt more quickly by borrowers.
Faster Transmission of Changes in the Interest Rate
Under the MCLR system, the interest rate on loans is linked to the marginal cost of funds. This means that when the cost of funds for banks changes, the interest rate on loans will also change. This allows for faster transmission of changes in interest rates to borrowers.
Impact of MCLR on Lenders
MCLR has also had an impact on lenders. While it has led to increased competition among banks, it has also led to higher interest rate risk.
Increased Competition
Under the MCLR system, banks have to set their lending rates based on their marginal cost of funds. This has led to increased competition among banks, as they have to offer competitive rates to attract borrowers.
Higher Interest Rate Risk
However, MCLR has also led to higher interest rate risk for banks. This is because changes in the cost of funds can lead to changes in the interest rate on loans, which can impact the profitability of banks.
Conclusion
In conclusion, MCLR is an important concept for borrowers and lenders in the Indian financial market. It is a benchmark interest rate that is used by banks to determine the interest rate on loans and advances.
MCLR has several benefits for borrowers, including better transmission of policy rates and a more transparent methodology. However, it has also led to increased competition among banks and higher interest rate risk.
8. FAQs
- How often does MCLR change?
- MCLR can change on a monthly basis, depending on the changes in the cost of funds for banks.
- Can banks offer loans below the MCLR?
- Yes, banks can offer loans below the MCLR, but they cannot offer loans above the MCLR.
- How is the tenor premium for MCLR calculated?
- The tenor premium for MCLR is calculated based on the perceived risk associated with longer tenor loans.
- How does MCLR impact deposit rates?
- MCLR can impact deposit rates, as it can lead to changes in the cost of funds for banks.
- Can borrowers switch from the Base Rate system to the MCLR system?
- Yes, borrowers can switch from the Base Rate system to the MCLR system, but they may have to pay a conversion fee.