What is the Difference Between Base Rate and MCLR?

• MCLR is based on the marginal cost of funds, while Base Rate considers the average cost of funds.
• MCLR includes a tenure premium for longer-term loans but Base Rate does not factor in loan tenure.
• Banks must publish MCLR in loan for different tenures, making it more transparent than the Base Rate.
• MCLR is revised monthly, while the Base Rate could be changed quarterly, making MCLR more dynamic.
• Loans linked to MCLR are more responsive to changes in the RBI's policy rates compared to Base Rate loans.

When you're looking to take out a loan, especially a home loan , it's important to understand how banks calculate the interest rates they offer. In India, there are two main benchmarks that banks use: the Base Rate and the Marginal Cost of Funds based Lending Rate, or MCLR.Although these two benchmarks might seem similar, some significant differences between them can impact the interest rate on your loan. Let's find out more.

The Base Rate system was introduced by the Reserve Bank of India (RBI) in 2010. It replaced the Benchmark Prime Lending Rate (BPLR) and set a minimum rate below which banks were not allowed to lend, except in certain cases.To calculate the Base Rate, banks considered factors like:

• Average cost of funds
• Operating expenses
• Minimum rate of return (profit margin)
• Cost of maintaining Cash Reserve Ratio (CRR)

Under this system, banks had some flexibility in determining their cost of funds. They could change their Base Rate every quarter.

In April 2016, the RBI introduced the Marginal Cost of Funds based Lending Rate (MCLR) to replace the Base Rate system. Like Base Rate, MCLR acts as a benchmark rate below which banks cannot lend.However, bank MCLR rates is calculated differently, based on:

• Marginal cost of funds (92% based on marginal cost of borrowing, 8% on return on net worth)
• Operating costs
• tenure premium (for loans with longer tenures)
• Negative carry on account of Cash Reserve Ratio (CRR)

Banks must publish their latest MCLR rates for different tenures, ranging from overnight to one year. Also Read: Everything about the Base Rate in a Home Loan

Now that we understand the basics of MCLR vs Base Rate, let's look at the five main differences between these two benchmarks:

The Base Rate was calculated using the average cost of funds, minimum rate of return, operating expenses, and the cost of maintaining CRR and Statutory Liquidity Ratio (SLR).In contrast, the MCLR calculation is based on the marginal (incremental) cost of funds, operating costs, tenure premium and negative carry on CRR only. SLR is not considered.

Under the Base Rate system, banks could consider average, marginal or blended cost of funds.
With MCLR, banks can only consider the marginal or incremental cost of funds, which is more dynamic.

The Base Rate did not factor in the loan tenure when calculating interest rates. All loans, regardless of duration, were priced using the same Base Rate.MCLR, however, includes a tenure premium. This means banks can charge higher interest rates for loans with longer tenures, to account for the higher risk involved.

Banks were allowed to revise their Base Rate every quarter.In contrast, banks must revise their MCLR rates every month. This makes MCLR more dynamic and responsive to changes in the cost of funds.

The Base Rate system lacked transparency, as banks had flexibility in calculating the cost of funds and there was no standardized formula.MCLR follows a more defined formula set by the RBI, which improves transparency. It is also more responsive to changes in the RBI's policy rates, leading to better transmission of monetary policy.

Understanding the difference between Base Rate and MCLR is a great starting point in your loan journey. But there are a few more steps you can take to make an informed decision:

• Assess your current loans , if any. Check whether they are linked to Base Rate or MCLR, and compare the interest rates with current offerings.
• Use online MCLR calculators to compare rates from different banks. Factor in the reset period and any additional charges.
• Negotiate with banks . Many banks offer discounts on their published current MCLR rates, especially for borrowers with good credit scores.
• Consider the long-term impact . While a lower interest rate is important, also look at factors like loan tenure, processing fees, and prepayment charges.
• Seek expert advice . Consult with a financial advisor or loan expert who can help you understand the nuances of MCLR vs Base Rate and choose the best option for your needs.

By taking these steps, you can ensure that you're getting the best possible deal on your loan and making a decision that supports your long-term financial well-being. Also Read: Understanding Repo Rate: What It Means for You?