Marginal Cost of Fund based Lending Rate, or MCLR, is a concept introduced by India’s apex bank, the Reserve Bank of India close to a year ago. It is a method used to calculate interest rates on advances, and differs from the previous norm of calculating interest rates based solely on the base rate system. The earlier system allowed the banks a fair amount of discretion when it came to determining the lending rate.

The MCLR has come into effect from April 2016, while having been announced prior to the said date.

What is MCLR all about?

For a quick understanding, you should know that the MCLR is calculated on the basis of four major components, i.e. –

• Marginal cost of funds
• Operating cost
• Tenure premium (which is the additional slab of interest over the base rate, which in turn is dependent on the loan tenure and commitments)
• Cost of maintaining the cash reserve ratio, or CRR

If that sounds too much of a technical mouthful, what it simply boils down to is, MCLR is the cost of obtaining funds for banks, linked to the repo rate. What this means is that even the smallest change in the repo rate will impact the MCLR and thereby the bank’s lending rate. For a customer however, it does spell good news on occasion – given that MCLR is reported on a monthly basis, if there are any interest rate cuts in that period, the same benefit would need to be extended to a customer by the bank.

For banks, since the MCLR is a tenure-based rate, there is the likelihood of them having to publish at least five MCLR rates across the overnight, one-month, three-month, six-month and one-year tenures. If the banks so choose, they may also set up rates for a longer period, of even as much as two to three years.

What does the introduction of MCLR translate into?

For starters, more transparency, because under MCLR the interest rate that a bank would lend at, is linked to the incremental borrowing cost that a bank incurs.

Given that MCLR is not linked to the repo rate as announced from time to time by the RBI, if the repo rate falls, it does not necessarily hold good that the interest rate on your home loan would take a dip as well. Only if the borrowing cost (of funds) for a bank is lowered, will the MCLR come down, resulting in a cheaper home loan for the customer.

Earlier, where the interest rate that a bank would fix for your loan did not take into account a spread additionally that factors in an individual’s risk profile or creditworthiness, i.e. a person’s ability to repay a loan.

Will all loans move to the MCLR regime?

No, it is floating interest rate loans that will get linked to MCLR. Fixed rate loans will not be impacted by this recent introduction.

If you have availed of a floating interest loan recently, it will automatically be linked to MCLR. This implies a slight documentation change, one of which is a reset clause and the other is that you are offered a spread. Remember that this reset clause will depend on each bank, and may vary. So depending upon the tenure, the interest rate will be reset, depending upon the deposit rates prevailing at the time. What the spread implies is that, the customer would now be required to pay a margin that is pegged over and above the MCLR.

Is it wise to switch from a base rate to MCLR, then?

While prima facie it does look tempting to switch, it is more judicial to wait and watch. Factor in the switching cost, because your lender may just levy additional charges for the change. Of course, the way MCLR is laid out, it offers more transparency in dealings to the customer, hence from their point of view, it is definitely beneficial. But before you make the final move, do keep in mind that once you switch to the MCLR regime, you would not be able to change back to the base rate structure. Further, if you do wish to make the change, you as the borrower would need to reach out to your bank. Switch then, if the difference in rates is significant enough to warrant the move.

The bottom line

As with any other loan, shop around before you make the final decision, and opt for the best credit solution available to you.

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