What is MCLR: Meaning, Full Form, Rate Calculation, Factors, Differences & FAQs

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09 OCTOBER, 2024

The full form of MCLR is Marginal Cost of Funds Based Lending Rate. It is the minimum lending rate below which the Banks are not permitted to lend. The Reserve Bank of India implemented MCLR on 1 April 2016 to determine interest rates for loans. It is a replacement of the earlier base rate system to determine the lending rates for commercial banks. It applies to all types of loans borrowed from lending institutions such as Kotak Bank. Moreover, the MCLR rate is based on the nation’s economic activities. Usually, registered lenders cannot lend money at an interest rate lower than the MCLR.

Read on to learn more about MCLR, the factors affecting it, and how it is different from the base rate.

What is MCLR and its Rate?

When it comes to MCLR meaning, it is the lending rate below which Banks are not permitted to lend. Its primary objective is to address issues associated with the base rate regime, helping borrowers make their borrowing decisions. For instance, when looking for a Kotak Home Loan, a borrower can monitor the MCLR rate and avail the benefits of a reduced rate. Regarding origin, the MCLR replaced the Base Rate system to enhance the monetary policy’s effectiveness and increase transparency in setting interest rates.

MCLR is the lowest interest rate a lending institution offers on a loan. It closely relates to the repo rate and the bank's fund cost. Whenever the repo rate changes, it also impacts the floating interest rate on loans. That means when the MCLR rate decreases, the floating interest rate on a loan also reduces. Although it might not affect the EMIs, it may reduce the repayment tenure.

How is MCLR Calculated?

The MCLR calculation depends on various borrowing sources for a lending institution, including fixed deposits, savings accounts, current accounts, etc. Interest rates of all these borrowing sources help calculate the MCLR borrowing rate. The mathematical formula to calculate the rate is as follows:

Marginal cost of funds = interest earned on existing funds - interest earned on new funds

The marginal cost of funds includes borrowing through various sources such as savings accounts, term deposits, and other short-term and long-term borrowing instruments. Negative carry due to Cash Reserve Ratio (CRR) refers to the cost incurred by banks for holding reserves with the central bank that do not earn any interest.

Operating expenses cover the costs associated with the bank's day-to-day operations. In contrast, the cost of maintaining the Statutory Liquidity Ratio (SLR) represents the expense of holding government securities as mandated by the central bank.

A tenure premium may also be added to reflect the risk associated with lending over different tenures. This ensures that the MCLR appropriately reflects the varying costs and risks of different loan tenures.

Which Factors Impact MCLR?

Several factors influence the MCLR of a lending institution, including the following:

Cost of Funds: This is the cost at which a lending institution acquires funds from different sources, such as loans, deposits, and other funding options. The interest rates of these sources directly affect the MCLR rate.
Marginal Cost of Funds: It is the additional cost the bank incurs to acquire money for lending. It includes operating costs, the central bank’s repo rate, and the CRR and SLR Statutory Liquidity Ratio expenses.
Negative CRR: It poses a formidable challenge as it drains liquidity, creating hurdles for banks in their lending endeavours. Its presence casts a shadow over monetary policy decisions, altering the landscape in which financial institutions operate. Policymakers grapple with understanding its nuanced impact amidst the ebb and flow of the financial currents.
Tenure: Whether short or long, the tenure of an agreement defines the duration of borrowing, shaping the trajectory of financial transactions. It is a pivotal element in the intricate ballet of lending and borrowing, influencing the dynamics of the financial ecosystem.
Operating Expenses: The bank's operational costs include administration, infrastructure, employee salaries, and technology investments.
Profit Margin: Lending institutions aim to earn profit from lending money. They consider their desired profit margin when determining the MCLR rate. It ensures their earnings are enough to cover the associated costs and provide reasonable investment returns.
Market Conditions: Inflation rates, economic factors, and market liquidity are crucial in determining the MCLR. The aim is to ensure the lending rate remains competitive according to the prevailing market conditions.
Credit Risk: A borrower’s creditworthiness determines the MCLR rate. Lending institutions assess an applicant’s credit risk and charge a higher interest rate from high-risk borrowers.

What is the Difference Between MCLR and Base Rate?

To avoid confusing MCLR with the base rate, let’s look into the differences between them:

Parameter	MCLR	Base Rate
Meaning	MCLR means the minimum lending rate below which a financial institution cannot lend.	It is the minimum lending threshold set by the RBI.
Factors	The MCLR rate depends on CRR, tenor premium, operating costs, and marginal cost of funds.	The base rate depends on the bank’s profit, costs, and deposit rates.
Association with the RBI	It depends on the repo rate determined by the RBI.	It does not depend on the repo rate set by the RBI.
Scope of Change	The MCLR rate may be different for various loan terms.	Lenders may change the base rate at regular intervals.