Financial Benchmark

Understanding MCLR

The **Marginal Cost of Funds Based Lending Rate (MCLR)** is an internal benchmark interest rate for banks in India. Introduced by the Reserve Bank of India (RBI) in April 2016, it replaced the previous **Base Rate** system.

In simple terms, MCLR represents the **minimum interest rate** below which a bank cannot lend money. The actual interest rate a borrower receives is calculated as: **Final Loan Rate = MCLR + Spread** (Spread is the mark-up added by the bank). Since MCLR is reviewed and published monthly, it ensures that changes in the RBI's policy rates (like the Repo Rate) are passed on to borrowers more quickly and transparently.

The MCLR is calculated based on four primary components, providing a clear and formulaic basis for setting the lending rate:

• Marginal Cost of Funds (MCOF): This is the dominant component (around 92% weightage) and accounts for the average rate at which a bank has raised funds (deposits and borrowings) during the review period.
• Negative Carry on CRR: This is the cost incurred by the bank for maintaining the Cash Reserve Ratio (CRR) with the RBI, as these reserves do not earn any interest.
• Operating Costs: The day-to-day operational expenses of the bank related to providing the loan product.
• Tenor Premium: An additional charge or premium added to the rate to account for the risk associated with the specific tenure or length of the loan. Longer tenure loans typically carry a higher premium.

MCLR primarily affects **floating rate loans**, such as most Home Loans, Loans Against Property, and certain Business Loans. Personal loans and fixed-rate loans are generally not linked to MCLR.

The interest rate on an MCLR-linked loan is subject to a **reset period**, which is typically six months or one year. When the MCLR changes, the interest rate on your loan will only change after the next scheduled reset date.

• If a bank's **MCLR decreases**, your loan interest rate (and likely your EMI) will reduce after the reset period.
• If a bank's **MCLR increases**, your loan interest rate (and likely your EMI) will increase after the reset period.