What is the MCLR Rate? What Do You Need to Know About It?

In 2016, RBI replaced the base rate system of ascertaining commercial lending rates with MCLR. It is said to be a tenor-linked benchmark that helps to determine interest rates for loans and facilitates transparency in the computation of the same. Notably, there is a close cause and effect relation between MCLR and repo rate. To understand this, and to become familiar with the concept in-depth, individuals need to find out more than – what is MCLR rate?’ 

What is MCLR?

Essentially, the marginal cost of funds-based lending rate or MCLR is a minimum rate below which financial institutions cannot extend loan value to borrowers. Nevertheless, as a regulatory body, RBI has the authority to make some exceptions to it as and when required. Under it, financial institutions decide the rate of interest-based on the remaining repayment tenor of a credit. Also, the risk factor of loan application is factored in to determine the rates.

Before the introduction of this MCLR regime, it used to take a significantly long time to reflect the change in repo rate in the commercial lending rates. Contrarily, in this new regime, financial institutions must adjust their lending rates immediately after a change in the repo rate. Notably, under the MCLR regime, financial institutions have the authority to extend all credit options at either fixed or floating rates. 

The fact MCLR influences the cost-effectiveness of a credit option like home loan makes it vital for individuals to become aware of its impact. For instance, a hike in MCLR rate can push a loan EMI upwards. Regardless, borrowers can combat the effect by increasing their loan tenor and making part pre-payment to lower the loan EMI. Other than that, borrowers must also find out everything about MCLR-based home loans to manage the same smoothly. 

How is MCLR calculated?

Typically, financial institutions compute MCLR rate internally by factoring in some crucial elements. Some of them are discussed below –

Marginal cost of funds (MCF)

The average rate at which deposits with the same tenor were raised for a given period is the marginal cost of funds. MCF is computed by factoring in all the borrowings of a financial institution. The rates of interest accompanying such loans help to calculate the MCF. It mostly includes – the marginal cost of borrowings and the returns on net worth. 

Tenor premium

The cost of lending is determined based on loan tenor. Typically, higher loan tenure accompanies a greater risk; resultantly, to cover for the risk the financial institutions charge a premium. The said premium is known as tenor premium. 

Operating cost

This cost accounts for the expenses incurred by a financial institution to extend financial products like a home loan. While most consumers believe that financial institutions do not incur any additional charges, this is hardly the truth. Keep in mind that the operating cost refers to expenses, which are separate from the service charge for such loans.

Also Read: Is Staying on MCLR Based Home Loan Beneficial?

Negative carry on the cash reserve ratio

When the earnings on CRR are zero, it results in a negative carry on CRR. Negative carry influences the SLR reserve’s commercial banks. Generally, it is computed as – 

Required CRR x {marginal cost / (1-CRR)}

Nonetheless, before picking any MCLR-based credit, individuals must weigh the features of MCLR and their effect on loans.  It will help them to understand ‘what is MCLR’ better and will also help to make an informed choice regarding the switch from base rate to MCLR.

Individuals, who intend to avail a cost-effective credit option, may also consider availing a housing credit from a leading financial institution that provides a substantial loan amount at an attractive rate of interest.

Moreover, leading financial institutions extend lucrative pre-approved offers to their customers to make the loan availing process further seamless. Usually, such offers accompany financial products like home loans and loans against property, among others. You too can check your pre-approved offer in a few steps by entering details like name and contact number.

Financial institutions make it a point to review and publish fresh MCLR every month for financial products with different maturities. It must be noted that fixed-rate loan options that come with a tenor over 3 years and certain government-backed loan schemes are usually not linked to MCLR. Borrowers must find out ‘what is MCLR’ for a given period to understand the computation of interest rates better. 

Priya Bagga