MCLR - UPSC Notes

MCLR full form is Marginal Cost of Funds based Lending Rate. The Reserve Bank of India (RBI) gives a fixed Internal Reference Rate for banks under it. This Interest Rate is used by all banking and non-banking institutions as their minimum interest rate applicable for lending any loan. It has replaced the earlier Base Rate System, which was introduced in the year 2010, for determining lending rates for commercial banks.

What is MCLR?

It is the lowest rate of fund lending. No bank is permitted to lend below this. The methods used to renew credit limits and sanction loans are per MCLR norms. It is determined by banks internally, depending upon the loan repayment time.

In this article, discussed are the various important aspects of Marginal Cost of Funds based Lending Rate, significant from the UPSC exam perspective.

What is the MCLR rate?

The rate varies from one bank to another. For example, while the State Bank of India has a varying MCLR of 6.65% to 7.30%, the Bank of India has different sets of rates.

For quick reference, aspirants can check the present rate of MCLR on Bank of India’s website.

What is the purpose of MCLR?

Under MCLR, as soon as the Repo rate changes, banks must adjust their Interest Rates. MCLR is implemented to bring transparency and uniformity at the interest rate on advances followed by banks. It is also calculated that the interest rate is equally fair and beneficial for the banks and the borrowers. As a result, banks will improve their long-run value and become more competitive using marginal cost pricing of loans.

How is MCLR calculated?

While preparing for UPSC notes about calculating MCLR, all the sources where a bank borrows its fund should be considered. These include– fixed deposits, current accounts, savings accounts and equity or the retained earnings, etc. The rate of interest used in these sources gives us the Marginal Borrowing Cost of the bank.

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Which factors impact MCLR?

• Banks must maintain a Cash Reserve Ratio (CRR) of 4%.
• Banks can avail some allowance under MCLR; it is called Negative Carry on CRR. It happens when the CRR balance is zero, i.e., when the actual return is lesser than the cost of funds.
• The Operating costs related to providing loan products must be considered.
• There are other various expenses of a bank that are separately charged from the customers but are not part of the calculation for MCLR. They include fundraising, salary payment to its employees, new branch openings, etc.
• The last element is Tenure Premium. It is not specific to a borrower; instead, it is uniform for all types of loans. The tenure increases if the reset period is higher. With a longer duration of a loan, its risk increases. To cover this risk, the bank charges an amount from the borrowers. This amount is called the Tenor premium.

What is the reset of interest rates?

Banks generally publish their MCLR concerning different maturities every month on a specific date. However, they may also consider reviewing their MCLRs quarterly for the first year, after which they can go back to monthly reviews.

MCLR prevailing on the loan sanction date will continue till the next reset date. The tenor of reset may be a year or even lower. The exact tenor of reset will depend upon the loan contract terms.

What is the difference between MCLR and base rate?

The difference between MCLR and base rate is as follows:

• MCLR is an advanced version of the base rate.
• The base rate uses the average finance cost, but MCLR is based on the marginal or incremental cost of money.
• When calculating the base rate, a minimum rate of return/profit margin is used, whereas, for MCLR, banks are required to include tenor premium into the calculation. Thus banks charge a higher rate of interest for long-term loans.

Upon checking previous years’ question papers of the IAS Exam, aspirants can see that many questions have frequently come from this topic. Therefore, it is recommended that they thoroughly go through the notes to learn the various aspects of MCLR.

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