What is the Full form of MCLR?
The full form of MCLR is “Marginal Cost of Funds based Lending Rate”. MCLR is the minimum rate of interest with which a bank can lend. MCLR is an internal standard linked to tenor, meaning that the bank decides the rate directly based on the time left to repay a loan.
RBI has implemented the MCLR system for setting advance interest rates, effective from 1 April 2016. It replaced the previous process of the base rate system, which was introduced in July 2010 to measure the lending rates for commercial banks. MCLR was introduced by RBI on 1 April 2016 to assess the interest rates for loans.
How is MCLR calculated?
MCLR is directly related to the actual rate of deposit and is measured using four components.
- Tenor premium
The tenor is the length of time a borrower would have to pay back the loan. The tenor premium is uniform for all types of loans and is not borrower-specific or loan-class-specific.
- The marginal cost of funds
The marginal cost of funds comprises the marginal cost of borrowings and return on net worth.
- Operating costs
It is related to the delivery of the loan product, including the expense of raising money. It does not include the service charges.
- Negative Carry on account of Cash Reserve Ratio (CRR)
It occurs when the return on the balance of CRR is nil.
Justifications for MCLR introduction
Before the MCLR scheme, the various banks used various criteria to measure the base rate / minimum rate, including focusing on the marginal cost of funds, the average cost of funds, or the combined cost of funds. The reason for the implementation of MCLR is listed below.
- To bring transparency in determining interest rates.
- Making available bank credit at interest rates fair to lenders and banks.
- To help banks become more efficient, increase their long-term profitability, and contribute to economic development.
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