Marginal Cost of Funds Based Lending Rate (MCLR)

Key Components of MCLR

1. Marginal Cost of Funds: This represents the cost at which banks raise funds, typically through deposits and borrowings. For most banks, about 92% of their funding comes from borrowings, while the remaining 8% comes from returns on their net worth.

2. Negative Carry on CRR (Cash Reserve Ratio): This is the cost incurred by banks because they are required to keep a portion of their deposits with the RBI without earning interest.

3. Operating Costs: This includes all the administrative and operational expenses associated with providing loans.

4. Tenor Premium: This is an additional charge that banks apply for longer-term loans to cover the higher risks involved in lending for extended periods.

Example

Suppose you take a one-year floating-rate home loan from SBI in April 2025:

• SBI’s one-year MCLR = 9.00% per annum.

• Spread = 0.25%.

• Your effective loan interest rate = 9.25% per annum.

For a ₹50 lakh loan over 20 years, your EMI would be approximately ₹45,826 per month (using the standard EMI formula).

Benefits

• Transparency: Borrowers benefit from greater clarity on how interest rates are set and can anticipate quicker transmission of RBI policy changes.

• Fair Pricing: The rate reflects the true cost of funds for banks, ensuring borrowers are charged appropriately.

• Dynamic Adjustments: Interest rates are reset periodically (typically annually), so borrowers may benefit from reduced EMIs if MCLR falls.

Challenges

• Complex Calculation: MCLR involves several components and can vary by bank, making it challenging for borrowers to compare or fully understand how rates are set.

• Delayed Transmission: Banks might not reduce MCLR promptly after an RBI rate cut, delaying the benefits for borrowers.

• Limited Competition: If banks do not compete aggressively, MCLR rates can remain high even if RBI rates decrease.

Conclusion

MCLR plays an important role in determining the interest rates of floating-rate loans in India. While it brings transparency and ensures that changes in RBI policy are passed on to borrowers, it also presents challenges, such as complexity in understanding and potential delays in rate adjustments. Borrowers should be mindful of these factors while taking loans linked to MCLR.