MCLR Base Rate - Effects of it on Loans?

RBI regularly changes the benchmark rates at which it provides funds to the banks (Repo rate). The MCLR (Marginal Cost of Funds Based Lending Rate) system improves the transmission of the benefits of REPO rate reductions to the borrowers.

MCLR base rate is the minimum interest rate at which banks must offer loans. Banks set the interest rates as per the marginal cost at which they acquire funds through bank deposits and by borrowing from RBI. Any alteration in the RBI Repo rates changes the MCLR.Calculation of MCLR base rate depends on:

• The marginal cost of funds
• Tenure premium (the premium charged by banks for risks on long term loans)
• Operating expenses of banks
• Cost of maintaining Cash Reserve Ratio (the percentage of total bank deposits that the bank has to hold as a reserve with the RBI)

Every month the banks have to review Repo rates and other factors related to borrowing and announce overnight, one month, three months, six months, and one-year rates.

Only loans with floating interest rates sanctioned after March 31, 2016, are linked with MCLR. Usually, home loans, loans against property, and corporate term loans fall under floating interest rates.

Banks add the component of spread to MCLR to arrive at the actual lending rate. Spread is the difference between interest earned and interest paid by the banks on financial instruments. The MCLR on the day when the bank sanctions your loan is applicable. The interest rate will be revised according to the MCLR base rate prevailing on the reset date allocated to your credit.

Existing loan borrowers can switch to MCLR. At present, loans that follow MCLR are less costly than base rate loans. However, if the Repo rate rises, the interest rates on MCLR-linked loans will increase.

Apart from a prompt decrease in lending rates with cuts in Repo rates, MCLR brought transparency in the calculation of loan interest rates . Spreads are charged during loan sanction, and banks cannot alter it randomly. Interest rates are reset on allotted dates.

• Loans against deposits
• Loans to bank employees
• Loans under government schemes
• Fixed-rate loans
• Loans from NBFCs

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.