Marginal Cost of Funds based Lending Rate (MCLR) & Benchmarking of Loans

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 MCLR

(RBI Give formula to Bank to calculate his Minimum Lending Rate)
  • Marginal Cost of Funds based Lending Rate (MCLR) is the minimum interest rate, below which a bank is not permitted to lend, barring a few exceptional cases as permitted by the Reserve Bank of India (RBI).
  • MCLR, or Marginal Cost of Funds based Lending Rate, replaced the existing base rate system with a new measure for determining the lending rates for commercial banks
  • It was implemented by the RBI on 1 April 2016, to determine the rates of interests for advances.
  • It is an internal rate of reference for banks, to determine the minimum rates of interests for loans. For this, they take into account the additional or incremental cost of arranging additional rupee for a prospective buyer.
  • This rate is based on four components—the marginal cost of funds, negative carry on account of cash reserve ratio, operating costs and tenor premium.
  • MCLR is linked to the actual deposit rates. Hence, when deposit rates rise, it indicates the banks are likely to hike MCLR and lending rates are set to go up.
Objectives
  • To improve the transmission of policy rates into the lending rates of banks.
  • To bring transparency in the methodology followed by banks for determining interest rates on advances.
  • To ensure availability of bank credit at interest rates which are fair to borrowers as well as banks.
  • To enable banks to become more competitive and enhance their long run value and contribution to economic growth.
Problems
  • The transmission of policy rate changes to the lending rate of banks under the current MCLR framework has not been satisfactory.
  • RBI in its August Policy, 2019 pointed out that although it had brought down the repo rate by 75 basis points, the weighted average MCLR of banks had come down by only 29 basis points.
  • Banks argue that the MCLR formula is calculated based on the cost of funds and thus it comes down only gradually after a repo rate cut.
  • There is a strong likelihood that RBI will cut rates further to spur demand.
  • The external benchmark was first proposed by the former governor Urjit Patel in 2018. The norms for external benchmark linking of interest rates was scheduled to be operational from April 1, but owing to protest by the banks, the same was deferred.
[Fixed interest rate follow – MCLR.
Floating Interest rate follow – Benchmark of Loan.]
Benchmarking of Loans
(Bank choose any one bench mark given below for Lending Rate)
  • The Reserve Bank of India has made it mandatory for all banks to link all new floating rate loans (i.e. personal/retail loans, loans to MSMEs) to an external benchmark with effect from 1st October 2019.
  • The move is aimed at faster transmission of monetary policy rates.
  • Banks can choose from one of the four external benchmarks — repo rate, three-month treasury bill yield, six-month treasury bill yield or any other benchmark interest rate published by Financial Benchmarks India Private Ltd - Give Mumbai Inter Bank Lending Rate (MIBOR).
  • At present, interest rates on loans are linked to a bank’s marginal cost of fund-based interest rate, known as the Marginal Cost of Lending Rate (MCLR).
  • Existing loans and credit limits linked to the MCLR, base rate or Benchmark Prime Lending Rate, would continue till repayment or renewal.
  • Those customers wanting to switch to the repo-linked rate can do so on mutually acceptable terms.
  • Adoption of multiple benchmarks by the same bank is not allowed within a loan category.
  • The interest rate under the external benchmark shall be reset at least once every three months.


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