MCLR (Marginal Cost of Funds based Lending Rate)

Why in news?

  • State Bank of India (SBI), the country’s largest lender, reduced its benchmark lending rate — the MCLR — by 10 basis points (bps). 

MCLR (Marginal Cost of Funds based Lending Rate):

  • The marginal cost of funds based lending rate (MCLR) refers to the minimum interest rate of a bank below which it cannot lend, except in some cases allowed by the RBI.
  • It is an internal benchmark or reference ratefor the bank.
  • MCLR actually describes the method by which the minimum interest rate for loans is determined by a bank.
  • It is on the basis of marginal cost or the additional or incremental cost of arranging one more rupee to the prospective borrower.

The main components of MCLR:

  • Negative carry on account of CRR: is the cost that the banks have to incur while keeping reserves with the RBI. 
  • Operating costs: is the operating expenses incurred by the banks
  • Tenor premium: denotes that higher interest can be charged from long term loans
  • Marginal cost of funds: It is the novel element of the MCLR. The marginal cost of funds will comprise of Marginal cost of borrowings and return on networth. 
  • According to the RBI, the Marginal Cost should be charged on the basis of following factors:
  • Interest rate given for various types of deposits- savings, current, term deposit, foreign currency deposit
  • Borrowings – Short term interest rate or the Repo rate etc., Long term rupee borrowing rate
  • Return on networth – in accordance with capital adequacy norms.

How MCLR determined?

  • The MCLR is determined largely by the marginal cost for funds and especially by the deposit rate and by the repo rate. Any change in repo rate brings changes in marginal cost and hence the MCLR should also be changed.

How MCLR is different from base rate?

                                Base Rate                                    MCLR
Based on average cost of funds Based on marginal/incremental cost of funds
Calculated by considering minimum rate of return/profit margin Calculated by considering tenor premium
Base is also governed by operating expenses, and expenses needed to maintain cash reserve ratio. The MCLR is also determined by considering deposit rates and repo rates, along with operating costs and cost of maintaining cash reserve ratio.

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